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What should be your investment strategy for debt funds amid rising rates?

When it comes to the debt mutual fund category, liquid funds had the highest outflow, totalling  ₹59,970.30 crore, while August witnessed the highest net inflow, totalling  ₹50,095.82 crore. (istockphoto)Premium
When it comes to the debt mutual fund category, liquid funds had the highest outflow, totalling 59,970.30 crore, while August witnessed the highest net inflow, totalling 50,095.82 crore. (istockphoto)

  • Debt-oriented mutual funds experienced a net outflow of 65,372.40 crore in September 2022 amid the rising interest rates and inflation, as opposed to a net inflow of 49,164.29 crore in August.

Debt-oriented mutual funds experienced a net outflow of 65,372.40 crore in September 2022 amid the rising interest rates and inflation, as opposed to a net inflow of 49,164.29 crore in August. When it comes to the debt mutual fund category, liquid funds had the highest outflow, totalling 59,970.30 crore, while August witnessed the highest net inflow, totalling 50,095.82 crore. In comparison to the net outflow of -16,405.13 Cr reported in August, overnight funds showed the highest net inflow for the month of September 2022 at 33,128.33 Cr. In September, the net AUM for debt mutual funds fell to 12,41,674.09 Cr from the 13,03,233.66 Cr recorded in August. 

Consumer Price Index (CPI) data shows that retail inflation soared to a five-month-high level of 7.41 per cent in September. Since the Reserve Bank of India (RBI) has been raising the repo rate in the high inflationary situation to control inflation, the repo rate has been increased by 190 bps till now including the last 50 basis point (bps) hike taking it to 5.90 per cent. Since debt mutual fund schemes invest in fixed-income securities, rising repo rates and bond yields have an effect on the net asset value (NAV), particularly for long-term bond funds. A hike in interest rates is anticipated at the upcoming MPC meeting of the RBI, which will be held in December, as the yield on the 10-year Indian government bond climbed to 7.5% in October, the highest level in the previous four months. What investment approach should investors use for debt funds in light of the unpredictable market situation, where debt is thought to be less turbulent than equity?

Mr. Sandeep Bagla, CEO, TRUST MF said “In September, the system liquidity had turned tight due to high unspent government balances and FPI outflows from equity markets. Additionally, markets anticipated repo rate hikes by RBI and market yields went up as a consequence. In an environment of high uncertainty and volatility, debt flows witnessed net outflows as the returns had turned subdued."

He further added that “RBI is expected to hike the repo rates by another 60 bps in the coming policies, which could create some amount of volatility in the markets again. Domestic inflation remains high and may come down due to the base effect in the next quarter. We at TRUST MF feel that inflation due to high food prices, international commodities and high domestic wage pressures could remain high for longer. We are recommending to our investors to stay invested in funds with maturities lower than 2-3 years as one is able to generate higher than 7% return without taking interest rate risk."

“The ideal allocation for the retail investor could be 30% in Liquid/Money market fund 60% in Short term fund/BPSU debt fund and 10 % in Long maturity funds. We prefer to advise investors to remain underweight at the longer end of the curve. While yields have reason already to 7.50%, it is possible that yields climb higher if domestic inflation remains high," said Mr. Sandeep Bagla.

Debt market sees outflow in September. What is the reason for this? What should investors do?

Dipen Ruparelia, Head-Products, Vivriti Asset Management said “In the current month till Oct 28, FPIs sold ~ INR 1,500 crores (net) in the debt market, and ~ INR 300 crores (net) in the hybrid market. However, in debt-VRR, FPIs bought ~ 760 crores in the same period. Rising interest rates is a matter of concern across the globe as it expects to hinder growth. Nearly 90 central banks hiked interest rates this year with 50% of them going for a raise of at least 75bps. Other major factors attributing to the outflow include rising oil prices and the delay in the inclusion of Indian govt bonds in global bond indexes."

“In the current market environment, investors should look to invest in close-ended funds in order to lock-in the higher interest rate with a maturity of 3-4 years enjoy a better risk-reward spectrum for debt investments with an attractive yield on offer and some of the incremental rate-hikes likely priced in," he further added.

“Investors always prefer their investments in a more stable environment. The consecutive hike in interest rates by RBI to curb inflation is making the debt market less predictable and a little volatile. As the 10-year Bond Yield of India climbed to 7.4%, the spreads vs US bond yield narrowed to 3.6% as on Sep 2022 making the long-term debt investment less attractive. However, India is projected to grow at the fastest pace among major economies with its fundamentals remaining more or less stable despite global distress. Hence, India looks better placed as an investment destination for debt," said Mr Dipen Ruparelia.

How should investors go about deploying funds in fixed-income instruments, debt funds, or bonds in the context of rising interest rates?

“In order to avoid mark-to-market losses amid the rise in yields, investors should stay away from open-ended schemes to avoid volatility and invest in funds with close-ended structures that ensure no MTM volatility. AIFs with similar structures will become one of the best investment vehicles in such a situation, especially the ones which are close-ended to protect the volatility and have a tenure of 3-4 years to lock in higher yields arising due to a rise in interest rates. Debt fund managers who pursue portfolio deployment at higher yields due to rising interest rates and those who also follow innovative structures like first loss protection that reduce credit risk are expected to attract investors," said Mr Dipen Ruparelia.

What are the current risks that investors should be aware of and what should be their portfolio allocation towards debt funds?

“Investors should avoid allocation to long-term (5-10 years) funds as they would be highly volatile and pose higher interest rate risk. They should follow accrual-based strategies and allocate a certain percentage of their portfolio to performing credit space to generate positive returns post-tax and -inflation. They should evaluate asset managers with deep expertise and a team to manage debt funds that are investing in operating companies with proven business models and stable cash flows," said Mr Dipen Ruparelia.

The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.

ABOUT THE AUTHOR

Vipul Das

Vipul Das is a Digital Business Content Producer at Livemint. He previously worked for Goodreturns.in (OneIndia News) and has over 5 years of expertise in the finance and business sector. Stocks, mutual funds, personal finance, tax, and banking are among his specialties, and he is a professional in industry research and business reporting. He received his bachelor's degree from Dr. CV Raman University and also have completed Diploma in Journalism and Mass Communication (DJMC).
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