As steady as debt

The last three years fetched below average returns for debt fund investors. As interest rates increased from about 7 to about 11 per cent currently, average returns from all debt funds tumbled to just around 5.5-6 per cent as net asset values declined. But now the worst is perhaps over. Interest rates have stabilised and could come off a little as inflation has eased to 3.07 per cent.

Banks have already started reducing their lending rates on home and car loans. This stability bodes well for debt funds. Says K. Ramkumar, Head (Fixed Income), Sundaram BNP Paribas AMC: “With inflation at a five-year low, interest rates are likely to come down and the Reserve Bank of India is likely to maintain a more neutral stance.” Besides, the real return from debt investments has turned attractive lately yielding about 2-3 per cent higher than about a year ago.

Says Mohit Verma, CIO (fixed income), JM Financial Mutual Fund: “The real interest rate has turned attractive now increasing by about 250-300 basis points.” Debt is back, at least for now. So where should you invest? For starters, there’s a broad menu of debt funds: floaters, short-term funds, gilt funds, liquid funds, etc. Investing in debt depends on current interest rate scenario.

Says Sanjay Matai, Promoter, wealtharchiprices have an inverse relationship. When interest rates fall, the market adjusts bond prices to increase the interest rate yield — which means their prices rise. Mutual funds holding these bonds show an improved return as their net asset values (NAVs) rise.” The short-end of the yield curve — which shows interest rate movements across various tenures — is more attractive now.

Says Ashish Nigam, Head (Fixed Income), DBS Cholamandalam AMC: “Oil prices of around $90 a barrel is a concern. Hence, we recommend that investors avoid long-term debt funds.” Investors must match their investment horizon with that of a debt fund.

The rates, though stable, can still go out of hand in an adverse situation, and that tends to increase the risk of a long-term debt fund against its short-term counterpart. “Therefore, investors are better off looking at short-term bond funds that typically have a maturity of 6-12 months with a yield of 7.75-8 per cent for a one-year horizon,” says Nigam.

Agrees R.V.S. Sridhar, Senior Vice President (Treasury), Axis Bank: “Better yields are available in short-term paper making them attractive investment options these days. Also, when rates are uncertain, the risk of a loss is lower in short-term debt funds compared to long-term funds.” A new class of schemes — liquid plus funds — is the flavour of the season. The returns here are better than normal liquid fund, but the risk is marginally higher. The cost structure is similar.

Says Ramkumar: “A liquid plus is something which is positioned between a short-term and liquid fund. Investors with an investment horizon of a few weeks should go in for liquid plus funds, which offer a better yield, without taking on much additional risk.” As each category of debt funds has unique characteristics that depend on the type of investment and its holding period, it’s best for investors to evaluate a portfolio with the risk profile. For now, as the yields are better on short-term paper, investors may be better off investing here.

Additional reporting by Clifford Alvares