The Reserve Bank of India (RBI) increased the repo rate, which is the rate at which commercial banks borrow from the Central Bank, by 225 bps to 6.25 per cent in 2022, to reduce liquidity leading to yields rising across maturities. Consider this: the 10-year bond yield jumped by 13 per cent upto 7.61 per cent in 2022.
Accordingly, debt funds did not do well in 2022 and had a lacklustre performance of an average return of 2-4 per cent, as they saw the prices of their holdings going down. This is because when interest rates rise, bond prices fall and since debt mutual funds need to mark their net asset values (NAV) to the market daily, the bond prices dropped and NAVs suffered.
But now with the interest rates expected to be near their peaks, is it a good time to invest in debt funds? Should one invest in FDs or debt funds in 2023?
Experts say that in 2023 they are positive on debt funds as it has become an attractive asset class given the higher yields amid rising interest rates. One can consider categories like dynamic bond, credit risk, savings, ultra-short for debt allocation requirements.
“Given the widespread belief that investors should only participate in equities, the big call in 2023 is that investors should also invest in debt. In India, credit has grown by 20 lakh crore over the past year, and the government has a net borrowing programme of 12 lakh crore, of which 6 lakh crore will come from the insurance industry and other sources. The banks must provide the remaining borrowing of almost Rs 6 lakh crore. In the meanwhile, the deposit growth is just Rs 15 lakh crore of the required Rs 26 lakh crore. So, there is essentially a funding shortage in the debt market. In the past, asset classes with low investor interest have performed well in the short to medium term. A similar trend was visible in telecom, metals and PSUs as well three years back. Investors were reluctant to invest in these sectors and those are the very sectors which have delivered robust returns now,” says S Naren, ED & CIO, ICICI Prudential AMC.
Radhika Gupta, MD and CEO of Edelweiss AMC, agrees: “Our view has always been asset allocation focused. That said, rising yields offer one opportunity to lock in money at higher rates for the long term. So, long-term oriented target maturity funds in today's regime might be a very good option, especially for people who want to lock in for 10-15 years.”
Is it a good time to invest in debt funds compared to FDs?
It is a good time to park your money in debt funds, as apart from the prospect of giving higher returns they also have a tax advantage. While interest on fixed deposits is taxed on the basis of the tax slab you fall into, return from a debt fund is classified as long and short-term. If you redeem units before three years, capital gains are taxable as per the slab rate, while long-term capital gains are taxed at 20 per cent with indexation.
“Always a good time to be in debt funds compared to FDs for a full-time semester. Because in debt funds, there is an indexation benefit. So, 20 per cent, on a 5 per cent rate of inflation, means you pay less than 10 per cent in tax versus marginal tax. I think when the government of India is helping you save tax, you should do it. And now the target maturity fund structure basically mimics FDs with that kind of safety, transparency, and liquidity,” says Gupta.
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