Volatile markets have led to a surge in debt products across tenures and returns. One of the main maxims in wealth generation is to protect the capital. Debt products got a major push in 2008, when the equity markets came crashing. Double-digit returns, especially in gilt funds that generated returns in excess of 20%, were a new phenomenon. And with that, the debt market for retail investors got a new philip in India.
Where to invest. Interest rates and return on debt funds play an interesting role. In a rising interest rate scenario, it is recommended to invest in short-duration funds, so that the investor can ride the wave up. However, in a scenario where there is a pause in the interest rate and where the rates are expected to come down, longer-duration funds having maturity in excess of a year and upwards are recommended. In the debt MF space, there are various categories of instruments like liquid, ultra short-term, short-term, income, dynamic bond and gilt funds. In the current scenario, the recommended choice for longer duration funds are dynamic bond funds and gilt funds.
Why invest in long-term funds. Gilt funds are in the news off late. The annualised three-month/six-month returns in top-performing fund houses are in excess of 15% , on a conservative basis. So, before you take the plunge, it?s crucial to understand where the gilt fund invests to generate returns.
Gilt funds. They typically invest in government securities (G-secs), issued by the RBI on behalf of the government. Gilt funds allow retail investors to participate in G-secs, which are traditionally available to large investors or institutions. With the interest rate pause by the RBI, the returns generated by gilt funds definitely provide succor when the equity markets have been in the doldrums.
Is investments in gilt funds risk-free? The answer is ? no?. Gilt funds do not carry credit risk, as the paper is issued by the government. However, they do carry an interest rate risk. That is, if there is any change in the interest rate scenario, gilt funds can be very volatile, as was the case over the last one month. However, if your investment horizon is in excess of nine months to one year, a double-digit return can be expected from them. Only those investors who can withstand short-term volatility should invest in gilt funds.
Dynamic bond fund. DBFs typically invest across debt products like G-secs, money markets, corporate bonds, and generate return by actively managing the portfolio.
The current annualised returns by the top-performing funds in this category for the 3/6 month duration are in excess of 10%. Again, DBF rides on the interest rate scenario and it makes the optimum use of the product profile to generate returns. As investments are across products, the risk are diversified compared to gilt funds.
This enables the fund manager to actively manage the funds and take calls to increase/decrease any component of the product profile to generate the returns. This is an attractive feature in the DBF, wherein the fund manager has the ability to manoeuvre, something that is limited in gilt funds.
However, DBF carries both credit and interest rate risks, as the issued papers are from the government as well as corporates. This is where the fund manager makes the best use of the resources and the understanding of the current economic environment. The DBF will be recommended to a conservative investor, who does not like the volatility that could be expected in gilt funds. The optimal way to invest is to have the asset allocation in place and invest accordingly.
Long-term debt instruments are recommended in every investor?s portfolio and you can use the current interest rate pause favorably, to generate fixed deposit-beating returns. As in every investment, investments in debt products do carry an interest rate risk and also credit risk, wherein the corporate papers are in the portfolio. However, as the maxim goes, ? taking no risk is also a risk?.
The writer is founder and managing partner of Zeus WealthWays LLP