With RBI reducing Repo rates by 75 basis points in last 6-9 months, most of the funds in debt fund category have generated better returns than FD. Macro-economic factors are looking favourable for India and there are possibilities that due to constant improvement in GDP and inflation data, RBI may reduce repo rate by another 75-100 basis points in next 1 year. So, investors who are looking for some medium – long term investment can invest in debt funds now to capitalise benefit of the rate cut in next few quarters.
What are debt funds?
Debt fund is a mutual fund scheme which generates return by investing money in debt or fixed income instruments like corporate deposits, bonds, money market instruments, etc. These instruments have different maturities and different coupon rates. Debt fund do not fluctuate much compared to equity, hence less risky and good for risk-averse investors. The main objective of debt category is to generate fixed or regular income with aim of capital appreciation in the long term.
How does debt fund work?
Many types of debt funds are available in market. Basically they are categorized on the basis of duration. Debt funds invest in debt instruments (listed or unlisted) based on their maturity period. For instance a liquid fund will invest into those instruments which have a maturity of 1-7 days. A short term debt fund will have those papers whose maturity will fall between 1-3 months. A fund manager always invests into highly rated securities to maintain funds credibility. There are many reasons for debt fund price to fluctuate however, the most important reason being the “interest rate”.
When the interest rate falls, the price of the security (bonds) increases and vice versa. It is the duty of the fund manager to keep a check on the interest rate and generate returns for the investors.
Type of debt funds
Mutual fund structures the schemes under different type of investment objectives and each scheme is named after its objective. Debt fund invests in debt securities and demands a return in the form of interest (not fixed) which is paid back to the investor at the time of redemption.
Debt security can be issued by Government, financial institutions, banks, companies, public sector undertakings (PSU), etc. Some of the debt securities are treasury bills (T-bills), commercial papers (CP), certificate of deposit (COD), bonds/debentures, etc.
Below mentioned funds are some of the popular debt funds available in the market.
- Gilt funds
- Fixed Maturity Plan (FMPs)
- Liquid Funds or Ultra Short Term Funds
- Short Term Funds.
- Income Funds
- Dynamic Bond Fund
- Floating rate funds
- Corporate Bond Funds
- Capital Protection Funds
- Monthly Income Plans
Performance of Debt Funds in Last 1 Year
After the change in the central government, the equity markets started performing well. The inflation came down drastically and even the macro economic factors were looking favourable for India. Analysts started predicting about RBI reducing interest rate in next 1-2 years and as a result people started investing hugely into debt funds. As expected, during the period of April 2014 – June 2015, RBI has reduced the repo rate by 75 basis points due to which many of the debt funds have generated superior returns in this short period. Some of the funds in short term category generated more than 10% returns clearly outperforming the overall sector. In the income fund category few have generated returns more than 12%.
Below table shows the yearly return generated by Income fund category during May 2014 - May 2015
Currently repo rate is at 7.25%. With the continuously increasing GDP and other favourable macro-economic factors many analysts feels that RBI still have the scope of reducing repo rate by 75 - 125 basis points in the next 1 year. However, much depends upon the position of monsoon this year. Although it looks promising but it may also end up generating less return if the repo rate remains stable.
So for investors who are looking to invest into debt funds for not less than 2 years and are comfortable with the interest rate movement then they should go with income funds or dynamic bond funds as it invest into long term papers. These are interest rate sensitive and are capable of generating good returns in this long period. And for those who want less risk and looking for short term or medium term investment, then they should definitely look for short term funds or ultra-short term fund.
When it comes to investment and selection of scheme, one should always look into the right balance between growth, risk and return on investment. It is always good for the investors to analyse the trend of the interest rate and then take a call about investing in debt funds. And those investors, who are looking for some help, can contact their investment advisors as they will guide them in a better way according to their risk profile.