There is no exposure to equities in debt funds and the underlying securities include a mix of money market instruments, private sector bonds, government securities etc. Some debt funds are only into government securities called Gilt funds, while those primarily in private sector bonds are Credit risk funds. So, what could be the reason for the sudden fall in the debt funds NAVs that investors are seeing?
The impending effect of rising inflation could be the reason that most believe. As growth comes back not just in India but globally, inflation is being seen to rise. “Globally, yields have moved up due to higher commodity prices. The market is worried, this may lead to higher inflation in the coming years forcing central banks to hike interest rates,” says Nagarajan.
Rising yield (or falling bond prices) happens when bond investors dump existing bond holdings in expectation of high-interest rates in forthcoming bonds. For growth, the government needs funds and often resorts to borrowing from the market to meet the shortfall. “ Higher borrowing programme of the government is the main reason for upward movement in yields,” adds Nagarajan.
Noticeably, NAVs of Gilt funds and ‘Gilt Fund with 10-year constant duration’ are two categories that have fallen the most in the short term. Nagarajan says “In the last one month, ten-year bond yields have moved up by 30 basis points, 2 years to the 5-year segment has seen yields moving up by 50 to 80 basis points, the 15-year segment yields have moved up by 40 basis points. The benchmark for the Gilt fund is 11 years and market players if they are holding any positions, could have made losses. As the yield curve has moved up across the maturities, we are seeing this steep fall in Gilt funds.”
Strategy for investors
So, what should investors do now? “We advise investors to stick to the asset allocation framework and be patient to tide over the volatility in different asset classes. Changing asset allocation can be disastrous for the investors as all asset classes have their ups and downs,” suggests Nagarajan.
However, if the spike in the yields continues in near future, it may be better for investors to shift funds within the debt fund category. “ Investor who require the money in the next 6 month to one year, can look to redeem from the high duration products and invest in low duration products.” and, for investors looking to park funds in debt funds for meeting goals which are around three years away, Nagarajan says “The low duration category and money market category could be the categories in which the first-time investors can look at investing. As we expect interest rates may move up we don’t recommend long-duration funds. Investors may only invest in funds which have a good portfolio and avoid funds taking credit calls.”