Investor and founder of the Vanguard Group John Bogle once said, “Don’t look for the needle in the haystack. Just buy the haystack.” While this may certainly be tongue in cheek, this is certainly applicable to the debt segment of the Indian MF industry.
While debt mutual funds (MFs) may have had a rough May, experts feel that the asset class is stable and that investors may continue to be invested in this asset class.
“Debt Funds let investors invest regardless of market fluctuations provided the underlying portfolios are geared towards safe credits,” says Umesh Sharma, CIO-Debt, The Wealth Company Mutual Fund. Debt is inherently less volatile than asset classes such as equity, commodities or real estate and so provides much needed balance to the portfolio.
Sharp redemptions
This was in context that Debt-oriented schemes had witnessed significant redemptions of approximately ₹97,000 crore in May, led by outflows from the shorter end of the curve, particularly liquid, overnight, and money market funds. The withdrawals were driven by tighter liquidity conditions, which pushed short-term yields higher. Elevated Bank CDs and securities papers supply further weighed on the short end of the market.
Additionally, sustained energy price levels and concerns over El Niño’s impact dampened sentiment, with investors anticipating tighter monetary conditions ahead of the Reserve Bank of India’s policy meeting in early June.
The May redemptions were largely driven by liquid, overnight, and money market funds, which are often used by institutions for short-term treasury needs. This should not be seen as a structural weakness in debt , say market watchers.
‘Debt funds in a good place’
Experts are unanimous that debt MFs are in a good place.
“The outlook for remains stable, but investors should be selective,” says Saurav Ghosh, co-founder of Jiraaf.
“Debt funds are in a reasonably good place heading into the second half of the year,” says Harsha Vardhana VM, Founder-CEO, Atom Privé Financial Services. The 10-year government bond yield has come off from around 7% at the start of June to about 6.77% now, which means investors who were already in medium to long-duration funds have quietly made money this month without much noise. Please note, that bond prices and yields move in opposite directions, or when bond prices rise, yields fall.
The ₹97,000 crore outflow that made all the headlines in May needs a bit of context before anyone reads too much into it. Most of that money was corporate treasury cash that came in at the end of the financial year and went back out once the new quarter started and advance tax payments kicked in. It is a pattern that repeats itself.
Retail investors had very little to do with that number.
“The underlying picture for debt funds is actually quite different. Yields are positive in real terms, the rate cycle is still working in investors’ favour, and June has quietly turned into a decent month for bond fund returns,” says Harsha Vardhana VM.
“Investors should therefore continue to allocate to debt based on their investment horizon and risk appetite, rather than trying to time the market,” says Sharma.
Important caveat
There is the caveat that it is important to consider which part of the yield curve to take exposure to, since longer maturity portfolios carry substantial interest rate risk.
In the current context, Sharma believe that retail investors should continue to focus on the short to mid segment (up to three-four years), due to attractive interest income.
Experts also guide the investor how to look at debt MFs for their investment portfolio.
“The most sensible positioning right now runs across two categories,” says Harsha Vardhana VM.
For investors with a conservative profile and a one to two year horizon, short-duration and low-duration funds offer stability without significant interest rate risk.
For investors with a slightly longer view and moderate risk appetite, medium-duration and dynamic bond funds make sense because they capture the benefit of further yield compression without going all the way out on the curve.
Gilt funds offer the highest upside if yields fall further but also carry the most volatility.
Credit risk funds are best left alone unless the investor has a very specific mandate.
Sharma advices retail investors to pick funds on the basis of their investment horizon and risk appetite. The underlying funds should focus on safe credits with low to moderate interest rate risk.
With this as a background, he recommends funds with maturities up to three to four years like Money market, corporate bond fund, short duration funds or banking and PSU debt funds etc. depending on investment horizon.
“Investors should not move from debt funds to equity funds only because of one month of outflows,” says Ghosh when asked if investors now need to prioritize equity for their investments over bonds and debt.
Debt and serve different roles. Debt funds and bonds help with liquidity, fixed income allocation, and portfolio stability, while equity funds are meant for long-term growth and carry higher volatility.
Ghosh advices investors to hold debt funds for near-term goals and consider government bonds or investment-grade corporate bonds where they want defined maturity and regular payouts. Equity exposure can continue through SIPs for long-term goals, but debt allocation should remain an important part of overall asset allocation.
Debt funds are best approached as a long-term, stabilising allocation rather than a tactical bet on the direction of interest rates — the favourable backdrop today should not tempt investors into taking on duration or credit risk that sits outside their comfort zone.
The discipline that matters most is matching the fund to one’s own investment horizon and risk appetite, staying with safe credits, and choosing managers with a demonstrated, through-the-cycle track record. “Get that right, and debt does exactly what it is meant to do in a portfolio — act as a steady anchor — regardless of how the rate cycle unfolds from here,” says Sharma.