0% return! Debt mutual fund investors in for a shock in FY22

Mutual fund managers have been cautioning investors to lower return expectation from debt mutual funds this year. They believe, investors should expect low single-digit return from the bond market in FY22. "Investors at the short-end (up to 2Y) will probably earn zero or negative real return (inflation-adjusted) in FY22, similar to FY21," says Dhawal Dalal, CIO-Fixed Income Edelweiss AMC. Investors will have to increase their average maturity in order to optimise their risk-adjusted returns, he adds.

Dalal instead recommends to invest in high-quality bonds maturing in 5Y or higher. "Invest through passively-managed target maturity bond index funds as well as bond ETFs to benefit from diversification, transparency, simple & clear investment objectives and predictability of returns for hold-to-maturity investors in our opinion," he says.

Edelweiss Mutual Fund and a few other mutual fund houses have launched target maturity funds in the last month. Some fund managers suggest a more conservative approach though. Given the high uncertainty over interest rate trajectory, they believe, it would be prudent for investors to be conservative in their fixed income allocation.

"Conservative investors should stick to very short maturity debt categories like liquid fund. With normalisation in liquidity and short term rates, liquidity fund performance could improve going forward. Investors in debt funds should lower their return expectation as potential for capital gains will be limited," says Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund.

According to Pathak, investors with longer holding period and appetite to tolerate volatility could look at dynamic bond funds which can change the portfolio's risk profile depending on the market situation. "We advise investors to have longer holding period to ride through any intermittent turbulence in markets," he says.

Based on hardening of bond yields in January and  February 2021, a number of investors were concerned with regard to their existing or potential fresh investments in the bond market and wanted to adopt a wait-and-watch approach for higher yields. Dalal says, "the worst is possibly behind us as far as movement in yields are concerned. Based on that, investors are requested to get invested at the earliest and not wait for an opportune time."

G-SAP 1.0 along with option for Open Market Operations (OMOs) by the RBI  have eased the benchmark 10 year G-Sec yields from the levels of 6.1 and 6.2 to 6.03 as on  April 08, 2021. RBI measures will ensure that the yields at the longer end of the curve remain anchored. January and February saw yields hardening.

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A fall in bond yields bodes well for debt fund investors as bond yields and prices move in opposite directions. The NAV of the debt mutual fund schemes move up when the yields fall.

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