Fixed Income: Select your debt fund investments carefully

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Updated: Sep 01, 2020 12:46 PM

Invest in top quality instruments in the debt market such as Government of India bonds, AAA rated blue-chip companies and PSU bonds to preserve your capital.

The fall of a popular leasing company in 2018 surprised and upset debt mutual fund investors.

The covid-19 pandemic followed by a series of lockdowns has impacted the economy. This has impacted the revenue of firms, households, individuals, etc. Due to this, investors wish to play safe and invest in relatively safe instruments, especially in debt funds. Let us discuss in detail what are the issues in the debt markets and how investors should determine where to invest in debt funds.

Mixed trend

The fall of a popular leasing company in 2018 surprised and upset debt mutual fund investors. Again, during April 2020 another popular international mutual fund closed its half a dozen debt schemes due to significantly lower liquidity in the Indian bond markets. This led to an unprecedented volume of redemption. Many fund houses started side-pocketing, thus separating the stressed assets from other investments and cash holdings of a particular scheme. At the same time, retail investors started looking at products considered less risky such as banking and PSU funds. This is evident from the latest issue of Bharat Bond ETF which got oversubscribed by three times and mopped up around Rs 100 billion.

Covid-19 impact on debt markets

Owing to COVID-19 and various measures taken by the government to contain the same, there are unexpected challenges facing the government and the private sector. The government and Reserve Bank of India have announced various schemes as a stimulus to revive the economic activities, but the impact of these is yet to be seen.
Many global rating agencies have predicted negative GDP growth for the current fiscal. This will definitely affect companies with weak balance sheets and inadequate working capital. Investors could witness in the foreseeable future steeper yield curve and higher credit spreads between highly rated (AAA) and not so highly rated bonds. In order to ease monetary policy, RBI reduces interest rates and infuses surplus liquidity. This encourages investors to look at other financial products in the market and not just savings in the form of fixed deposits in the banks.

What investors can do

Given the current context, investors should stay invested only in AAA rated instruments. Investors should invest in top quality instruments in the debt market such as government of India bonds, AAA rated blue-chip companies and PSU bonds to preserve their capital. In the current economic scenario, following the above strategy will definitely lower volatility in their portfolio.

Further, investors should choose funds with a portfolio duration that is longer than their investment horizon in the current timings of interest rate easing. This will help to manage the interest rate decline in favour of return on risk-return matrix. Further, they should stay invested in highly rated short-term funds with a holding period of two to three years. If your holding period is less than one year, it is better to look at instruments in the money market rather than the debt market.

To conclude, investors must understand that the current investment landscape is novel coronavirus induced and as of now the prudent move is to preserve and protect your capital instead of focusing on returns.

(The writer is a professor of finance & accounting, IIM Tiruchirappalli)

 

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