Put fresh money in short-term funds

If you recently started moving from bank fixed deposits to debt funds, things might not look promising. Investors in debt funds that invest in long-term papers have begun seeing negative returns recently. The reason: The rise in bond yields, and as the price and yields move in the opposite direction, the returns were impacted.

In the past four months, the bond yields have been firming up for various reasons, including rising crude prices, the government saying that it would borrow an additional Rs 500 billion via bonds to fund its fiscal deficit, and so on. “We see the bond market to start stabilising here on. Existing retail investors in long-term debt funds should stay put. Those investing fresh money should go for shorter duration debt funds that have AAA-rated papers,” says Suyash Choudhary, head-fixed income, IDFC Asset Management.

In the last week alone, when the government announced that it would go for additional borrowing, the returns of long duration debt funds took a hit. The average one-week returns of income funds fell 0.09 per cent, dynamic bond funds were down 0.14 per cent, medium- and long-term gilt funds saw 0.35 per cent fall. The average returns from these are in the negative for one and three months, too. “Bond yields may not rise much from here but volatility would continue depending on crude price movement and what market is expecting from the upcoming Union Budget,” says Dhaval Kapadia, director-portfolio specialist, Morningstar Investment Adviser (India).

Kapadia says a retail investor should have a mix of debt fund in their portfolio. Within this, the investment in dynamic and long-term bond funds (or income funds) should not be restricted to 20-30 per cent of the portfolio, depending on your risk appetite and experience. If you have recently moved from fixed deposits to debt funds, don’t look at longer duration funds. 

If you have already invested in these categories and your allocation is just 20-30 per cent, then let your funds remain as they are. Remain invested for the next three to five years depending on your investment horizon, as these funds are volatile in the short term.  “Most fund managers are making changes to their portfolio based on the current market and future expectations. Dynamic bond funds and income funds may do better from here on,” says Choudhary. But if your allocation is higher to these categories, you can slowly redeem your investments over the next few months and move to shorter duration funds. Do keep exit load and tax in mind when redeeming.

When allocating fresh money to debt funds, it’s best to opt for shorter duration funds in the present circumstances. These include categories such as liquid, ultra-short-term and short-term funds. Schemes in these categories have average returns of over 6.29 per cent. Before you invest in these funds, ensure that the average maturity of the scheme matches with your investment horizon.

Credit opportunity funds have been the best performing among all debt funds, with an average return of 7.76 per cent in the past one year. But they are as risky as long-term schemes. Restrict your investment even in credit opportunity to 10-20 per cent of the portfolio.

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