Debt funds, both short-term funds and long term debt funds are considered to be a safe haven as they are able to protect the capital of the investors, however, these funds can also give smart returns if one is able to play them right.
Playing it right for a debt investor, of both types – short term funds and their longer version means taking a call on interest rates and thereby inflation. Higher interest rates and higher inflation are not good for the health of the economy as well as the debt fund investor. Thus in the current scenario in India, the investor is in a dilemma.
Reserve Bank of India has for the first time in five years increased interest rates on two sequential policy meets. This has been done in anticipation of higher inflation on account of government increasing minimum support price (MSP) for farmers and higher salaries by way of House Rent Allowance (HRA) to government employees on the domestic front and higher fuel prices and currency war on the international front.
Also Read: What is an ETF – and should I buy one?
High interest rate is considered bad for debt mutual funds, especially the longer-term debt funds more than the short term funds. When interest rates or yields rises the price of a bond falls, thus impacting the performance and net asset value (NAV) of a mutual fund. This is especially true for long-term debt funds rather than short-term funds.
In a rising interest rate scenario, short-term funds are better investments vehicles.
The general perception is that with two hikes of 25 basis points each, chances are that the central bank will not be increasing rates for the remainder of the year. Which in turn means that the long term funds are more at risk of interest rate changes than short term funds.
However, this being an election year, the central bank will have relative freedom from government intervention. Thus if oil prices increase further and the trade war between the US and China results in an all-out global currency war, India will end up importing inflation. In such a case chances are that RBI may increase rates by another 25 to 50 basis points.
These are volatile times for the debt market investors and the best way to avoid being caught on the wrong foot is to invest in short-term funds where capital protection is more or less insured plus it has the added advantage of staying away of volatility. The short-term funds which invest in Government securities like the two to five-year paper are good places to take cover.
Apart from short-term funds, investors can also look to park their money in Fixed Maturity Plans (FMP) which can also protect them from volatility. Investors can also look at one to three-year corporate bonds with high ratings. But unlike short term fund, which is play on keeping out of interest rate volatility in the short period the other two locks the investment at the current price and may not be ready for future dip in interest rate, if at all.
With various instruments, debt fund investors now have other places to park their funds apart from the conventional funds.