By Siddhant Mishra
The rising interest rate regime has put off investors, leading to a flurry of exits from debt funds. The rise in the interest rate has had an adverse impact on prices of underlying papers of mutual funds, since there is a negative correlation between interest rates and bond prices. Declining prices of underlying papers of debt funds have dented the investor confidence.
“Debt fund categories have largely been witnessing outflows over a considerable period of time. Although we’ve witnessed some inflows into short-term categories, these are largely owing to investors parking their short-term money into these. A rising interest rate environment that’s been in place since May 2022 has likely resulted in investors preferring to move out of debt markets in favour of equity,” said says Kavita Krishnan, senior research analyst, Morningstar.
According to data from Morningstar India, returns for various medium- and long-duration funds, along with corporate and PSU funds, ranged from -0.2% to -1.81% in May, before showing an uptick from June till August, and fluctuating between negative and positive territories in September and October. The only categories to show consistent positive returns have been those with short or ultra-short duration, where investors have preferred to park money.
In May, debt funds saw net outflows of Rs 32,722 crore. The figure stood at Rs 92,247 crore in June. In July, there was a marginal uptick of Rs 4,930 cr and August witnessed a surge at Rs 49,164 cr. However, there was a slump in September at Rs 65,372 cr and in October at Rs 2,817 cr, indicating that the sentiment towards debt funds over the past two quarters was weak.
According to Krishnan, macro indicators, such as rising current account deficit and rising import bill, are impacting the interest rate scenario. “Given these factors, the overall sentiment towards debt funds has been to invest in funds of shorter duration. Though some categories like long duration and gilt funds have witnessed some flows, they have largely been driven by liquid, ultra-short, short, and money market funds,” she added.
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According to a report by Mirae Asset, investing in funds that follow accrual strategies — holding the paper till maturity and benefitting from coupon payments — could help minimise the interest rate risk.
Dhirendra Kumar, founder and CEO of Value Research, said: “The move by the RBI to go for rate hikes was well expected and announced. Hence, there were no surprises and debt fund investors, who are mostly institutional investors, saw it coming and were prepared to pool their money out. They could have moved to short and ultra-short duration funds, which gave decent returns.”
He added that following a number of rate hikes, there could be some stability in the near term, and there is a chance of the trend reversing over the next two quarters. We could also see a rate cut over the next two quarters, which could boost flows back into debt funds.
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An industry player said returns in debt funds have largely been flat, except during the rally in markets over the past week. He believes while short-term funds have performed better owing to lower fluctuations, returns by long-term funds have been disappointing.
Debt fund experts said given that there is still scope of increase in rates, investors may continue to shy away from debt funds. However, most feel that the large part of the hikes is behind us. So, once some stability kicks in, medium- to long-term funds may do better. For the short term, liquid investments will continue to score.