Fixed Income: Adjust Your Debt Fund Strategy Now

With rising interest rates, mutual fund investors are redeeming their money market investments and low to short duration funds. In May, mutual funds reported a net outflow of Rs 32,722 crore after reporting a net inflow of Rs 54,756 crore in April. Higher yields and a preference for equities also affected flows to debt funds.

Data from the Association of Mutual Funds in India shows that money market funds recorded the highest outflows of nearly Rs 14,600 crore, followed by Rs 8,600 crore from short term funds and Rs 7 105 crore very short term funds. Only overnight, liquid and gold funds recorded inflows. There was also a reduction in the number of folios from 73.43 lakh to 72.87 lakh between April and May 2022.

Yields up

Since the start of 2022, long-term yields have increased by more than 100 basis points and short-term yields have increased by more than 150 basis points. Analysts say much of the potential rate hikes are already factored into current bond valuations and the yield spread between the three one-year bonds (6.94%) versus the three months (4.98%) is around 196 basis points compared to its 20-year long-term average of around 70 basis points. Soaring yields have caused difficulties for investors entering the debt market over the past year.

Short term strategy

Experts say as interest rates firm, investors should occasionally turn to short-term debt mutual funds and switch to long-term funds early next year. , as the Reserve Bank of India is expected to raise the repo rate by an additional 50 to 75 basis points (bps) by the end of this year, after raising the repo rate by a cumulative 90 bps to 4.9% in one little over a month.

For those with a short-term investment horizon, floating rate funds would be ideal. Puneet Pal, Head of Fixed Income, PGIM India MF, recommends investors increase their investments in actively managed short duration products while selectively reviewing dynamic bond funds based on their risk appetite.

Nitin Shanbhag, Head of Investment Products, Motilal Oswal Private Wealth, suggests that for fixed income portfolios, the core allocation should be in high credit quality target maturity debt funds that invest in a combination of instruments rated G-Secs, SDL and AAA. .

Akhil Mittal, Principal Fund Manager, Tata Mutual Fund, says it would be prudent to invest in debt funds with shorter durations as accruals are decent and duration risk is contained. “Rising overnight rates bode well for floating rate funds. Floating rate bonds can benefit from rate increases as accrued liabilities increase while the effective duration remains very low. So high predictability and lower volatility could make floating rate funds a well-suited choice at the current time,” he says.

Investors with a holding period of more than two to three years should look to aggressive bond funds that have the flexibility to change portfolio positioning as market conditions change. However, they may experience some intermittent volatility in portfolio value. In fact, medium and long-term interest rates in the bond markets are already at long-term averages relative to fixed deposits, which remain low.

Liquidity potential

After the sharp rise in bond yields since January, the return potential of liquid debt funds has improved significantly. Pankaj Pathak, Fund Manager, Fixed Income, Quantum Mutual Fund, says the spread between bank savings rates and liquid fund returns will widen and remain attractive. “Investors with a short holding period and a low appetite for risk should stick to liquid funds or good credit quality portfolios,” he says.

Track rate hikes

*Base allocation must be high credit quality target maturity debt funds

*For those with a short-term investment horizon, floating rate funds would be ideal

*Look at dynamic bond funds if you plan to hold more than two to three years

* The return potential of liquid debt funds has also improved significantly

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