Be prudent. Debt fund investors burn their fingers on interest rate uncertainty

Debt mutual fund investors have burned their fingers in the ongoing interest rate hikes by RBI to fight inflation. While debt funds were traditionally looked upon as an institutional product, mutual funds have been drawing retail investors with two per cent additional returns than the bank fixed deposit.

The uncertainty over interest rates result in lower bond prices impacting debt fund investors’ return.

In the last 10 months, the asset under management of all the debt funds, excepting for long-term and gilt funds, have dipped sharply with steady outflow continuing in these funds. Overnight and liquid funds were excluded as they are used largely by corporates for cash management.

Floater funds have registered the highest erosion of 38 per cent in asset to ₹60,638 crore in October against ₹97,798 crore logged in January while that of medium to long duration funds have dipped 36 per cent to ₹8,878 crore (₹13,966 crore).

Banking and PSU funds’ assets have dipped 27 per cent to ₹76,457 crore (₹1,04,417 crore). Assets of corporate bond and low durations funds have dropped 26 per cent each to ₹1,11,715 crore (₹1,51,204 crore) and ₹93,462 crore (₹1,25,957 crore).

Piyush Gupta, Director (Funds Research), CRISIL Market Intelligence & Analytics, besides interest rate movement, the increased interest in passive debt funds like target maturity funds which allow investors to lock on to the elevated yields in G-Sec, state development loans and top-rated corporate bonds for 3-5 years have reduced the attractiveness of the mainstream debt fund categories.

Interest rates are expected to remain elevated for the next couple of quarters with CRISIL Research expecting the 10-year g-sec yield to trend around 7.50 per cent by March 2023, he said.

In a target maturity fund, mutual funds hold bonds to maturity and if the investor remains invested for the entire tenure there is no probability of a loss.

Abhinav Angirish, Founder, Investonline.in said the hectic withdrawal seen from debt funds can be attributed to tightening liquidity conditions which prompted investors to raise cash.

Given the uncertain situation, it would be prudent for investors to stay away from long-term debt funds with a maturity profile of 5 to 10 years and focus instead on short-term debt funds for the next three years, he added.

Manish Kothari, Co-founder and CEO, ZFunds, said, with debt funds now carry higher yields and hike in interest rates are almost done, most of the debt funds ideally should deliver higher returns compared to last one year. 

Instead of cutting down investments in these debt funds, investors should try to match the holding period of their investments with the durations of the debt funds with maturity funds, he added.

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