The past month has been a rather disconcerting one for income fund investors as dismal returns have become a consistent feature.

Over the years, successive rate cuts had fuelled a strong rally in income funds and they were perceived as the best of both worlds i.e. safety with growth. The scenario has changed rather quickly following the recently announced Monetary Policy.

The RBI Governor chose to maintain status quo as far as the bank rate and cash reserve ratio are concerned. Markets which had factored in a rate cut took the news rather poorly and income fund performances bear testimony to the same.

In the past we have carried articles exhorting fixed income investors to consider income funds as alternative investment avenues.

Its time to revisit that hypothesis and check its validity in the present scenario. In an exclusive interview with Personalfn, Nilesh Shah, CIO-Debt, Franklin Templeton, offered the following advice to retail investors "Interest rates are not expected to move down sharply from current levels and hence investors need to tone down their expectations from income funds. Going ahead, coupon income and not trading gains will play a bigger role in the returns of these funds."

Clearly the irrational exuberance is a thing of the past.

Does this mean its time to exit income funds and head towards fixed deposits? Not really!

There are certain factors which offer income funds an edge over fixed deposits even in the present environment, e.g. liquidity is area where income funds score heavily over fixed deposits.

The investor has the option to exit without being penalised for the same. Dividends from income funds continue to be tax-free income for the investor.

Again the softer interest regime has taken its toll on fixed deposit rates as well. Their attractiveness from the investor's perspective has further declined.

Fixed deposits: Declining trends
Issuer 1-Yr State Bank of India 5.50% HDFC Ltd. 6.25% HDFC Bank 5.50% (As on August 2003)		Issuer 1-Yr State Bank of India 5.00% HDFC Ltd. 6.00% HDFC Bank 5.25% (As on December 2003)

So what should investors do?

The answer lies in being patient and not getting panicky. Exiting income funds at this stage and booking losses might prove to be the perfect recipe for disaster.

As an investor you must be willing to match your investment time frame with that of the product.

Don't expect an income fund with a long-term tenor to deliver returns in the short term period; such instances triggered by interest rate cuts could well be history!

Floating rate funds should also find a place in your portfolio because of their intrinsic ability to move with the market. A healthy mix of income funds and floating rate funds should do the trick.

As income funds rely increasingly on the coupon rate to generate returns, the gap between returns on income funds and fixed deposit rate is likely to trim down sharply.

However, going forward income funds hold an edge over fixed deposits in light of what we have outlined before.