Your Money: Debt Funds-Stop Playing Defensive

You can start taking exposure in debt funds as long as you have an adequate investment horizon.

For quite some time, yield levels in the market have been moving up, anticipating interest rate hikes by the Reserve Bank of India (RBI), which formally started on May 4, 2022. The common refrain in this phase has been, for fresh deployments, to prefer defensive funds (liquid, etc.) to wait out the period of volatility. For existing debt fund investments, it had gathered a ‘cushion’ depending on the time it was invested. There was no major issue for existing stuff, but returns were muted as interest rates were moving up and bond prices were coming down.

Current context

We are in the middle of a rate hike cycle by RBI. There may be predisposition to play it defensive even now, for fresh deployments. Nothing wrong with that. However, it needs to be understood how markets behave. Markets react in anticipation; without waiting for the actual event to occur. As mentioned earlier, in the context of the RBI rate hike cycle which commenced on May 4, 2022, yield levels in the secondary bond market have been moving up for more than one year. Similarly, the rate hike cycle is expected to last for the next six to nine months, but the market will position itself sometime prior to that. Hence, as long as you have an adequate investment horizon, you may start investing in your intended debt fund.

To illustrate the market discounting of events, let us look at some numbers. On May 3, 2022, or the morning of May 4, 2022 prior to the RBI repo rate hike announcement, the 10-year benchmark Government Security yield was 7.1%. Till date, including the repo rate hike on August 5, 2022, the repo rate has been hiked by 1.4%, from 4% to 5.4%. The level of the 10-year G-Sec being around 7.35%, it has moved up by around 0.25% since May 3, 2022. Now juxtapose this against the RBI rate action of 1.4%, you will get the perspective. Going forward as well, while the RBI would still hike rates, the market reaction in terms of yield levels moving up would not be as much.

The inference is, if you are waiting it out in defensive funds till the end of the rate hike cycle — well, there is nothing wrong in being defensive with your investment portfolio — but you need not be. Rather, you may follow the systematic investment plan (SIP) concept: start taking exposure over the next six to nine months. If the market reacts in terms of yields moving up, you will be catching a relatively lower NAV for entry in your debt funds. The theme is, it is not possible to catch the market peak or bottom, nobody knows it.

Where to invest?

There are multiple fund categories in debt, as many as 16 for open-ended funds. You can pick and choose any combination, as per your investment objectives and suitability. The category of target maturity funds (TMFs), though open-ended, is a separate variety. The advantage in TMFs is that there is a high degree of visibility of returns against the portfolio YTM (yield to maturity) of the funds. There being a defined maturity date, though there will be interim volatility in returns during your holding period, provided you hold till maturity, you will get returns somewhere around today’s YTM.

If you want good portfolio-credit-quality funds, there are corporate bond funds and banking PSU funds. There are short duration funds as well with decent portfolio credit quality. You need to check the portfolio maturity in the latest monthly fund factsheet, and your investment horizon should be somewhat commensurate with that. The name of the fund category, e.g., short duration, should not lead you to think that it is suitable for time horizons of, say, a few months. If your deployment horizon is short, e.g., a few months, you need to go defensive in liquid or ultra short duration or low duration funds. In these categories, the impact of market volatility is low, which is why it is suitable for short horizons.

For your existing investments in debt funds, just let it be, no action required. Returns over the past year or two have been muted, impacted by rising yields (traded interest rate levels) in the market. Now that the portfolio YTMs are higher than earlier, it is that much better for you, going forward.


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