"If returns from debt funds are this volatile, I would be happier to be in equity fund," Daga said.
Many other investors, who invest in income funds, share the same concern. In a sense, it also breaks the myth that income funds are similar to bank fixed deposits (FDs) and the capital will be guaranteed.
In reality, long-term bond funds, or income funds, can even eat into your capital.
Take, for example, JM Financial's Income Fund -- the worst performing fund in the category with -4.94 per cent returns. "The returns have suffered as some calls on interest rate movements went wrong last year. But we are trying to get into the top seven in the income fund category shortly," Shalini Tibrewala, fund manager at JM Financial Mutual fund, said.
What shouldn't be forgotten is that these funds also have inherent built-in volatility, because they are a function of capital markets. The returns can differ, depending on the call fund managers take on the interest rate scenario. And if you look at the spectrum of returns between the best and the worst performing fund, you will find a scheme at every increasing percentage point.
Income funds are most widely used by investors who want to add debt to give stability to their equity investments or they attract investors who are systematically withdrawing or investing in an equity fund. But the returns can vary drastically for many reasons: interest rate movement, redemption or size of the funds.
These funds buy papers issued by companies. And these bonds are issued at a premium to the prevailing rates. When interest rates fall, there is demand for good quality bonds that will yield higher returns.
But interest rate movements are unpredictable. The fund manager has to take a view of where they are headed and invests accordingly. If the rates don't move as expected, the result is negative or lower returns from a fund.
Returns can also be impacted if there are redemptions, because the fund manager needs to sell the securities to meet the redemption amount. "In this case, they may need to book a loss or profit depending on the paper sold," said Dhirendra Kumar, CEO, Value Research.
The papers sold are usually the liquid ones, after which the fund is stuck with securities that can't be sold in the market easily. This, too, hampers a fund's performance. And if this happens in a scheme that has a small corpus, it can have a drastic impact on returns.
Some of the better performing funds such as Canara Robeco, do not take applications above Rs 1 crore. "This ensures we do not have any volatile inflows or outflows," said Ritesh Jain, fund manager, Canara Robeco.
Jain said the fund house also realised quite early into the interest rate cycle last year that rates were headed lower. "We loaded on to higher duration papers from August to December-end. When we thought the markets have priced in every positive news and there is a chance of government overshooting on its borrowing programme, we added a lot of cash to the portfolio," he said.
Industry experts said small-sized funds did not perform too well in this category. This is because, to get higher returns, a fund manager needs to trade securities as well as hold some high-quality papers till maturity. A small fund size does not permit the fund manager to strike this balance. A single bond can cost anywhere from Rs 10 lakh to Rs 1 crore.
This is also apparent from the assets under management (AUM) of the top five and the bottom five funds. In the bottom five funds, the AUM is in single digits, except for JM Income (Rs 19.43 crore). Whereas the better performers not only have three-digit AUMs, their corpus has been steady.
Another reason some schemes have been hit was the rating of papers. "Between October last year and March this year, many AAA+ papers were downgraded. We have seen the valuation of mutual funds getting hit due to this," says a mutual fund expert.
But things seem to have begun to change for the bottom few. "We are being extra cautious now and churn our portfolio more. This has resulted in the fund moving from the bottom ranking to middle level in one month returns," says Tibrewala.
Even returns for some of the worse performing funds, such as DBS Chola Triple Ace and Magnum Income, have moved closer to the category bellwethers and better than the category average.
