When thinking of investment risks, we usually think of stock market risks. Equity investors have to deal with fluctuations in stock prices on a daily basis. However, there are several other forms of risks. If you are a debt mutual fund investor today, you would have experienced the effect of interest rate risks. Your investment would have taken a hit in recent quarters. What is interest rate risk? How does it impact debt investments, which are considered safe?
HOW INTEREST RATES IMPACT BOND YIELD
First, the basics. Interest rates have an inverse relationship with bond prices. Bonds are among the underlying assets in debt mutual funds. Bonds are debt instruments issued by the government of India, state governments, corporates and public sector companies. The bond issuer takes a debt and in turn promises to repay it with interest at an agreed date in the future. When interest rates go down, bond prices go up. When interest rates start rising, bond prices will fall.
DEBT FUNDS DURING RISING INTEREST RATE
Between 2014 and 2018, we saw the Reserve Bank of India reducing the repo rate seven times. During these years, several debt funds had a great run. In 2014, for exa-mple, many debt fu-nds returned 15-20 per cent. Now, the int-erest rate cycle seems to have bottomed out, and the RBI may start increasing the repo rate to tackle inflation. Alre-ady, banks are increasing the interest rate on loans and deposits. In the last ye-ar, we have seen debt funds return less than a fixed deposit. Several debt funds — which many investors look at as a smarter alternative to fixed deposits — have turned negative, or have performed poorly. For the one-year ending December 2017, the Crisil AMFI Perfor-mance Index shows GILT funds have returned 2.48 per cent, while debt funds return-ed 5.73 per cent.
TIME TO CHECK YOUR DEBT FUNDS
In the recent Union Budget speech, a higher fiscal deficit target was announced, and there is anticipation that the RBI will increase the repo rate. This will lead to volatility in the bond market. Therefore, it would be wise to rethink your debt mutual fund investments. More specifically, you have to give a hard look at what constitutes your debt fund. If your fund has allocated heavily towards securities whose average maturity period is very long (more than five years), you should act now.
MOVE OUT OF LONG-TERM DEBT FUNDS
India’s 10-year bond benchmark yield has risen steadily over the last six months. This has impacted long term debt funds, which include GILT funds and income funds. With the equity markets also being volatile in February and March, you would need a degree of stability in your investment portfolio. If you seek higher safety of your capital along with moderate returns, you should move to liquid funds and short term debt funds. For the one-year period ending Dec-ember 2017, the CRISIL AMFI Performance Index shows that liquid funds have earned 6.57 per cent and ultra short term funds have returned 6.81 per cent. These returns compare with or exceed fixed deposit returns. Switching from debt fund with securities of longer duration to liquid or short term funds would insulate your investments against interest rate risks.
Systematic Investment Plans (SIP) are usually advised for equity mutual funds while debt funds can be bought as lump sum investments. But given the volatility in the debt fund segment, you should avoid lump sum investments unless you're investing in liquid of short term funds. Long-term debt funds will start performing again at some point when the interest rates start falling. If you wish to invest in them, doing so through SIPs is advisable.