Mutual Funds

Fund Query: Is it the right time to do STP from debt funds into equity funds now?

Parvatha Vardhini C BL Research Bureau | Updated on June 20, 2021


I transferred 50 to 60 per cent of my equity fund outstanding to debt funds during October and November 2020 thinking that the equity market would fall sharply. But things are going contrary to my views. I have continued the SIPs in the equity funds as such. Now I plan to move my debt funds to equity funds in a staggered manner through STP and switch. Am I in the right direction? Please advise. When I transferred my funds from equity to debt funds like gilt funds and dynamic bond funds I thought that they would give at least 6 to 7 per cent return over one year. But the performance of the funds is very poor. Please explain the performance of debt funds under different market conditions.

K Ramachandran

We don’t have information on your age, your goals and and the time period allotted for them, the specific funds you have invested in and your risk profile. Due to this constraint, we limit ourselves to general advice based on market conditions.

While the stock markets have continued to rally even after you pulled out your funds, the risk of a correction looms large today. The risk has become even more pronounced after the recent US Fed meet indicated that discussions on tapering of the quantitative easing programme would commence soon.

Thanks to ultra-low interest rates in the US so far — maintained with a view to boost economic growth by encouraging spending — emerging markets such as India have been supported by investments from Foreign Portfolio Investors (FPIs), who came to India due to higher risk adjusted returns offered here. Now, a rise in US interest rates by 50 basis points by 2023, is indicated. This might start tempering foreign fund flows into Indian equity markets sooner than later.

It is best that you continue to hold your investments in debt funds for some more time before you make the move back to equities. You are anyway not missing the upside in the equity market entirely, as you have been continuing with your SIPs.

You should also consider the taxation aspect before you make such moves. At the time of your shift from equity to debt funds, you could have suffered long-term capital gains (LTCG) tax on gains over ₹1 lakh as well as short-term capital gains (STCG) tax if the sums (including SIPs) invested in the one-year period prior to October/November 2020 were also moved out. By doing STP from debt funds to equity within a short period, you will again suffer STCG tax. You can move from debt funds back into equity in a few tranches, once a correction in the equity market takes place.

A thumb rule can be:

If you are young or middle-aged and are a long-term investor with goals at least 7-10 years away, you can continue to remain invested in equity funds currently.

If you have goals less than three years away, it is best to preserve your corpus accumulated in equity funds so far by moving it to less risky instruments.

There is no promise of returns on debt funds. You need to choose the best debt fund categories to invest in, based on bond market conditions. We are assuming you switched to gilt funds and dynamic bond funds in October/November 2020.

Bond prices and interest rates are inversely related. The longer the maturity of the bond, the more sensitive their prices are to interest rate changes. Gilt funds work well when you enter them at a time when interest rates are expected to fall. For some time now, interest rates at best are maintaining status quo and may rise, going forward, if inflation continues to be sticky.This is the reason why gilt funds today show only an average one-year return of just 3.8 per cent. The underlying duration (average maturity) of dynamic bond funds depends on the call of the fund manager, which may or may not go right.

Today, based on the interest rate outlook, the best fund categories to invest in would be the low or short-duration categories and not gilt or dynamic bond funds. Else, floating rate funds with a low credit risk profile can also be considered.

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Published on June 19, 2021

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