Systematic investment plans (SIPs) have become the de facto method of investing in equity mutual funds. Monthly data from the Association of Mutual Funds in India (Amfi) shows that investors are willing to stay with their commitments despite a period of poor returns even if the conviction to increase their exposure is not there. But are SIPs only about investing in equity funds or is there merit in looking at periodic investing to take exposure to debt funds too?
SIPs help take the market timing out of investments. By following a periodic schedule, they invest at different market levels, which helps average out the cost of acquisition. For an SIP to give best outcomes, the investment’s values need to show volatility. In a secular rise or decline situation, therefore, SIPs are not the best strategy because in a rising market you are better off investing at one go as early as possible and if you know the prices are going to fall continuously, it is best to delay the investments to get a lower price.
Do debt funds, which are seen as steady investments with little volatility in returns, then qualify to gain from investing through SIPs? In 2019, the yield on the CCIL All Sovereign Bond Index, which represents 31 bonds issued by the central government with a minimum residual tenor of one-and-a-half years, began the year at around 7.5% and went down to 6.5% before ending the year at around 7%. The price of bonds moves in the opposite direction from the yields. If volatility is the principal criterion, then the debt market does qualify.
The other benefits of SIPs are bringing discipline and investing small surpluses that would be lying idle otherwise.
A look at how SIPs in debt funds have performed is relevant. The average three-year return from SIPs in the five best performing funds in the gilt fund category was 9.33% as against 7.11% in lump sum investment, a difference of 2.2%. In case of medium- to long-term duration funds, the difference was 1.71% and in case of short-duration funds, it was 0.70%. In case of ultra-short duration funds, the difference was only 0.20% and in case of credit risk funds, the difference was 1.37%.
However, lump sum investments are affected by the entry point bias, and in the case of three-year returns, the start period would be December 2016 or January 2017 when the debt markets were reeling under the impact of demonetization. “Bond yields had collapsed from around 7% to 6.25% because of demonetization at the end of 2016. You would have entered at a high NAV (net asset value) but the exit point NAV has not changed much because the yields went up to 8% in the interim and then back down to around 6.50%," said Arvind Chari, head of fixed income and alternatives, Quantum Advisors Pvt. Ltd, explaining the poor three-year performance of lump sum investments relative to an SIP that was started in that period.
The five-year return statistics seem to confirm this with the difference between lump sum and SIP returns falling to just 40 to 50 basis points for different categories of debt funds. The SIP advantage seems to be marginal if the entry point effect is taken into account. You will benefit by investing a lump sum when yields are high and bond values and NAVs are low. However, SIPs into debt funds hold their own on returns, irrespective of the levels of the market at the start of the investment.
You can use SIPs in debt funds to make better investment decisions. “SIPs in liquid funds have a lot of scope to add value to an investor. Tying yourself into an SIP at the beginning of the month when the salary is credited is a good way to protect targeted savings. Since there is no exit load on liquid funds after the initial few days, the investor can switch funds to their investments of choice," said Chari.
If you are just building a strategic allocation in your portfolio to categories such as short- or medium-duration funds, SIPs will not only fit into the plan of regularly investing surpluses but also protect them from entry point risks. “Investors may have other alternatives for building their long-term debt allocations such as the Sukanya Samriddhi Account for a girl child’s education, or the Public Provident Fund if liquidity issues can be overlooked, or even fixed deposits if the tax efficiency that debt funds bring is not a consideration. But after exhausting the limits in such schemes, SIPs into debt funds may be considered for building long-term corpus," said Chari.
Periodically switching funds from growth investments like equity into lower risk debt funds is an efficient way to rebalance the portfolio as goals come closer. The investor benefits at both ends when using a periodic exit or investment strategy. On one hand, the risk of redeeming the investments from the equity fund when the value is low is avoided and on the other, periodical investment helps reduce the impact of a high entry point. “An element of discipline comes into the rebalancing activity and the investor is not required to make the decision each time," said Chari. “SIPs are a good way to build a contingency corpus," said Gajendra Kothari, managing director and CEO, Etica Wealth Management (P) Ltd. “If the investor has a longer horizon, say, three years or more, they can consider equity for better returns," said Kothari.
Investors looking at SIPs in debt funds should consider the tax implications at the time of withdrawal too. Debt fund investments held over three years are eligible for indexation of long-term capital gains and the three-year cut-off for each instalment will be different.
Remember that the SIP is a facility. The decision on which debt fund to invest in comes first and this depends on the goal and the ability to take risk. At the next stage, decide whether the investment will be through an SIP or lump sum depending upon factors such as the suitability for periodic investment, the availability of cash flows and the trend in yields.