Mutual fund experts believe that debt fund will perform better in 2019 as compare to last. year 2018 was quit volatile year. Debt funds are very well placed in the market and should offer handsome returns to the investors. Hence mutual fund experts want investors to focus on their debt mutual funds in 2019.Due to the fall in equities last year,investors should understand the importance of debt and mutual funds in their portfolio. I believe this year, investors should focus on debt mutual funds equally as they are expected to do well and will raise the portfolio returns.
The last 1 year was a very volatile period for the Indian stock market. Though the Nifty is around 300 points or 3% higher on a year on year basis in February 2019, there are various factors impacting on the market including national and International The global impact like slowdown in the America, economic slowdown in China, America / China trade wars and the global consequences thereof, uncertainty about the form of Brexit, crude price outlook etc. Among local factors, the biggest is the political risk is upcoming Lok Sabha elections for the foreign institutional investors. Though the market has been range bound for the last few months, in our view, volatility is likely to stay in the near term.
Asset allocation is paramount in dealing with market volatility for investors. Asset allocation ensures liquidity, optimizes portfolio risk and provides stability, and helps investors achieve their financial goals in the short, medium and long term, regardless of market conditions. Debt mutual funds are good investment options in volatile markets from an asset allocation perspective.
What are debt mutual funds?
Debt mutual funds are mutual fund schemes which in medium to long-term debt instruments issued by private companies, banks, financial institutions, governments and other entities belonging to various sectors (like infrastructure companies etc.) are known as Debt / Income Funds. These securities pay a fixed interest rate (also known as coupon rate) to investors through the tenor of the security and the face value (principal amount) upon maturity.
What are the risks in debt mutual funds?
However, investors should note that debt mutual funds are also subject to market risks and are unable to provide guaranteed or risk-free returns. Debt and money market securities are subject to interest rate and credit risk in the capital market and their market prices. If interest rates rise, debt securities prices will fall and vice versa. Likewise, if a security's credit rating declines, its credit rating
Since these securities are contractually obligated to pay interest, the risk of these investments are much lower than equity, where the management is under no obligation to pay dividends. Furthermore, if you hold a debt security to maturity, the issuer is obligated to pay you the face value on maturity (assuming no default), unlike stocks whose prices are market driven.Debt funds are low risk profile funds that seek to generate fixed current income (and not capital appreciation) to investors. In order to ensure regular income to investors, debt (or income) funds distribute large fraction of their surplus to investors. Although debt securities are generally less risky than equities, they are subject to credit risk (risk of default) by the issuer at the time of interest or principal payment. To minimize the risk of default, debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be of "Investment Grade". Debt funds that target high returns are more risky.
A company must first fulfill its debt obligations before fulfilling shareholder obligations. In other words, if a company has issued both bonds and shares, it will have to make coupon payments to its bondholders, then pay taxes, and then decide how much profit after taxes it will pay to shareholders as dividends or reinvest in the business, which may result in shareholder capital appreciation. Compared to equity investors, of course, the risk to debt investors is much lower. If the visibility of earnings growth is not clear in an uncertain economic environment, debt funds are superior investment choices in n
Why are debt mutual funds appropriate under current (volatile) market conditions?
A company must first fulfill its debt obligations before fulfilling shareholder obligations. In other words, if a company has issued both bonds and shares, it will have to make coupon payments to its bondholders, then pay taxes, and then decide how much profit after taxes it will pay to shareholders as dividends or reinvest in the business, which may result in shareholder capital appreciation. Compared to equity investors, of course, the risk to debt investors is much lower. If visibility of earnings growth is not clear in an uncertain economic environment, debt funds are superior investment choices in the near-medium term.
Debt funds are significantly less volatile than equity funds. The average standard deviation in returns from short-term debt mutual funds is only 1.6%, whereas the average standard deviations of large-cap equity funds are 14.3% and that of multi-cap equity funds is 15.3% (source: Value Research); mid-and small-cap fund volatility is even higher. Debt mutual funds will provide portfolio investment income and stability in volatile markets.
From mid-2017 until October 2018, bond yields increased, after which the trend reversed. In January 2019, bond yields saw another spike and have since declined. The 10-year government bond yield, however, is 7.3 percent (even after dropping from the highs in recent months). By investing in accrual debt mutual funds, you can lock in these relatively high yields. These funds focus on earning interest income over the maturity of the security (hold to maturity strategy) from the coupons paid by the portfolio's debt securities.
Economists believe the peak is approaching U.S. interest rates. The monetary policy of the US Federal Reserve indicates a break in rate hikes. This will result in softening interest rates and bond yields and higher bond prices. The interest rate policy of the Fed will have ramifications toward a more accommodative interest rate regime on interest rates around the globe. The RBI reduced the repo rate by 25 bps in our country and the monetary policy of RBI shows a shift from inflation to growth concerns. CPI inflation has cooled to 2.05 percent, the lowest in the last 19 months, according to the latest data; this will give the RBI interest rate regime room for more accommodation. With lower interest expectations
Debt mutual funds, held for a period of 3 years or more, are much more tax-friendly than traditional fixed-income investment options in India such as Bank FDs and Small Savings Schemes from the government. Bank FD interest is taxed according to the investor's income tax rate, while debt fund capital gains are taxed at 20 percent in the long term (held for more than 3 years), after allowing indexing benefits. Indexation benefits significantly reduce investors ' tax obligations.
In the current economic climate, which debt mutual funds should you invest?
For the bond markets, 2017 and 2018 have been difficult years, but the conditions appear to be favorable as discussed above. Very short-term funds such as overnight funds, liquid funds etc. were the top-performing categories of debt mutual funds in 2018. But with expectations of further interest rate loosening, low-to-medium-term funds can outperform in the near-to-medium term due to bond price appreciation (with declines in yield). The yield curve (term interest rate structure of bonds of different maturities) was much flatter 6 months ago, but since then it has been steepening and longer-term bonds look better from a trade-off risk return point of view.
You should remember, however, that the yield trajectory inflection occurred just 3-4 months ago. Given the background of the global risk factors discussed at the beginning of this post, we still have significant concerns about the Rupee Dollar exchange rate, which may affect bond yields. For investors with a conservative or moderately conservative risk appetite, low duration and short-term debt mutual funds are therefore more appropriate investment choices compared to long-term or even medium-term debt mutual funds. Investors should note that the interest rate risk is higher than the length of a debt fund.
Conclusion
We discussed in this blog post why debt mutual funds in the current volatile market conditions are good investment options. Volatility may last for a while, so you have to pay attention to your allocation of assets. Under these volatile conditions, debt mutual funds will provide stability and also income for your investment portfolio. Mutual debt funds are also much more tax-efficient than traditional investment in fixed income. In this post, we also discussed the types of debt mutual funds which, taking into account local and global risk factors, will be suitable for you in current economic conditions and short-term funds have low interest risk and high yields can benefit.
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