In the past week, yields in the debt market have risen due to COVID-19 driven selling. A jump in yields causes prices of bonds to fall, and hence, debt funds to suffer. However, debt funds at the short end of the spectrum such as liquid or ultra short funds are considered not to be very sensitive to such shocks. This is on account of the short maturity of the paper they hold. The past week has seen this assumption challenged with these categories also taking a hit.
Rajeev Radhakrishnan, Head Fixed Income at SBI Mutual Fund noted two reasons for the spike in yields. "First, Investors prefer to hold more cash at year end and that requirement has gone up due to the current volatility. Second, stay-at-home and organisational disruption has reduced dealer presence in the market," he said. Financial firms based in India’s economic capital of Mumbai have been asked to introduce work-from-home policies for their staff to contain the spread of coronavirus.
On an average, liquid funds have delivered 0% over the past week, according to data from Value Research and many large liquid funds have actually delivered negative returns. Ultra Short Duration Funds have given -0.48%, money market funds have given -0.51% and low duration funds have delivered -0.91%. These are categories that normally do not deliver negative returns, even over short time periods and are considered extremely low risk.
One way for investors who have very short-time horizons to cut this type of risk is to invest in overnight funds. These funds invest in paper maturing in a single day, and hence, carry virtually no interest rate risk. However, they offer a much lower yield at around 4.5% currently. Debt Fund managers have cautioned investors against moving to overnight funds in reaction to this very transient scenario.
"The average yield difference between overnight and liquid funds is about 1.5%. So anyone with a horizon of 30 days or more would be equal or better off in liquid funds even if yields rise by up to 3%, assuming 45 days liquid fund duration," said Dwijendra Srivastava, chief investment officer (CIO) for debt at Sundaram Asset Management Company. Since a 3% jump in yields is an extremely rare occurrence, investors will be better off in liquid funds, Radhakrishnan of SBI Mutual Fund concurred.
“Investors need not switch from liquid to overnight for any time horizon more than a few days. We expect some sort of market intervention to bring down the yields soon," he added. Market participants have speculated RBI intervention in the debt market to bring down yields.
Investors should not unduly panic from what is a very rare occurrence in the debt market. If your time horizon is less than 1 week, you can look at overnight funds. This is because liquid funds have an exit load for periods up to 7 days from the date of investment.