Time for short, medium debt funds

It is a well-known fact that investors do not invest in debt mutual funds with the hope of earning double-digit returns. Further, while a fixed deposit provides a guaranteed fixed income, the returns are considerably lower than investment in debt mutual funds. Typically, debt funds are also added to an investment portfolio to offset the significant risk inherent in equities.

Financial experts say it is often prudent to invest in the shorter end of the yield curve, where volatility is lower. Last year the interest rates were reduced aggressively due to pandemic; therefore, it helped longer duration debt fund post-double-digit returns. However, shorter duration funds took a hit.

Bond prices and interest rates are inversely related to each other. So, when interest rates go up, bond prices fall, and vice versa, the impact of bond prices is reflected in the Net Asset Value (NAV) of mutual funds. As per the market experts, therefore, in the prevailing scenario, it is less risky to invest in short-duration and medium-duration debt mutual funds if interest rates are expected to go up.

That said, selecting debt funds is not simple. With sixteen subcategories defined by Amfi and little knowledge of why debt fund net asset value (NAV) change, it’s unsurprising that investors often choose funds based on near-term returns without understanding the risks.

It is important to note that the investment in debt funds should be aligned to the objective of the investors, and there are multiple categories available with varying credit risk and interest rate risk combinations for the investors to choose accordingly. Investors with a five-year horizon and the ability to withstand volatility throughout that time period can benefit from long-duration funds. Further, investors should favour fixed-income funds at the shorter end of the yield curve, particularly those with a term of three months to one year, keeping with the current interest rate environment.