Considering that over 60 per cent of mutual fund assets are invested in debt funds, the distressing scenario in debt markets is a matter of concern for a lot of investors. It's no secret that inflation, enemy no.1 as far as debt markets are concerned, is to be largely blamed for this situation.
Let us understand what are the reasons, behind the volatility in debt markets and how investors can salvage their debt portfolios from erosion under the circumstances.
1) Rising crude prices were primarily responsible for raising the bogey of inflation and sending debt markets in a tizzy. Inflationary concerns were 'fuelled', to use a pun, more in light of events in the global oil market than anything at the domestic level.
However, the inflation numbers have now come off their highs mainly due to the base effect. At 7.10 per cent (WPI) inflation is a lot 'tamer' than what it was a couple of months ago at over 8.00 per cent.
But no one is writing off inflation as yet, least of all the Reserve Bank of India. In the latest Monetary Policy, the RBI raised short-term interest rates by hiking the repo rate by 25 basis points to 4.75 per cent.
Rajiv Anand (Chief Investment Officer - Stanchart Mutual Fund) asserts, "Inflation will be watched more closely now given RBI's relative bias over containing inflationary expectation."
Binay Chandgothia (Dy CIO - Principal Mutual Fund) concurs, "Inflation will be a cause for concern; there is no doubt about that, for a period around six months."
2) Rising interest rates, which are a corollary of higher inflation, is the other concern.
This long-standing concern translated into reality when the RBI raised short-term rates in the Monetary Policy. However, it left the bank rate untouched at 6.00 per cent. The view is that oil and inflation will dictate where interest rates are headed.
Rajiv Anand elaborates, "Market attention will be irrevocably focussed on oil prices as well as on weekly inflation henceforth. Any rise in these will lead the market to price in a higher expectation of a further hike. Conversely, if these factors ease over a period of time this expectation may abate as well."
However, given that debt markets have nonetheless reacted adversely to inflation and fears of a hike in interest rates, there has been above-average turbulence in the debt fund investor's portfolio.
Hardest hit have been investors in long-term debt funds be it plain vanilla bond funds or gsec/gilt funds. We have highlighted the performance of leading long-term debt funds in the country. Evidently, they have fared most unimpressively over one year.
Long-term Debt Funds: Losing propositions!
| Long-term Debt Funds | NAV (Rs) | NAV DATE | 1-Mth | 6-Mth | 1-Yr |
| BIRLA INCOME PLUS B | 27.39 | 15-Oct | -0.58% | -3.26% | -2.38% |
| GRINDLAYS SUPER SAVER G | 15.31 | 15-Oct | -0.86% | -3.47% | -2.30% |
| PRU ICICI INCOME G | 19.26 | 15-Oct | -0.13% | -2.73% | -1.91% |
| DSP ML BOND G | 22.40 | 15-Oct | -0.16% | -2.62% | -1.87% |
| TEMPLETON INCOME G | 23.33 | 15-Oct | -0.15% | -2.52% | -1.26% |
We have tried to chart out a plan of action for the debt fund investor in view of the depressed scenario in debt markets.
1) Investors can consider investing in floating rate funds. Floating rate debt funds invest in floating rate paper, unlike plain vanilla debt funds that invest in 'fixed coupon' paper.
Floating rate instruments have their coupon rates linked to a benchmark, like for instance the MIBOR (Mumbai Interbank Offered Rate). This means that floating rate instruments have their coupon rates adjusted at periodical intervals in line with the changes in the MIBOR.
This tends to reduce price fluctuations in a floating rate fund arising out of interest rate volatility, particularly in a scenario with a bias towards rising rates.
Floating Rate Funds: Top performers
| Floating Rate Funds | NAV (Rs) | NAV DATE | 1-Mth | 6-Mth | 1-Yr |
| DSP ML FLOATING RATE G | 10.72 | 17-Oct | 0.43% | 2.35% | 4.82% |
| TEMPLETON FLOAT LTP G | 11.72 | 15-Oct | 0.35% | 2.18% | 4.77% |
| BIRLA FLOATING RATE LTP G | 10.69 | 15-Oct | 0.40% | 2.25% | 4.72% |
| PRU ICICI FLOATING RATE G | 10.77 | 17-Oct | 0.37% | 2.24% | 4.71% |
| GRINDLAYS FLOATING G | 10.83 | 17-Oct | 0.37% | 2.15% | 4.53% |
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This should underline to the investor the stark difference in the performance of the two debt fund categories from a single fund house.
1) Short-term plans of debt funds is another option for the cautious debt fund investor. Short-term plans invest in shorter dated paper, i.e. debt paper with lower maturity. There is also significant chunk invested in cash/call money. This tends to insulate the fund from volatility in debt markets which impacts longer dated paper.
2) Liquid funds also witness lower turbulence for the same reason as short term plans. Liquid funds are more suited for the investor with an investment horizon of about a month, while investors with a slight longer investment time frame (up to 3 months) should consider short-term plans.
Liquid Funds: Smart parking options
| Liquid Funds | NAV (Rs) | NAV DATE | 1-Wk | 1-Mth | 6-Mth | 1-Yr |
| SAHARA LIQUID G | 11.64 | 17-Oct | 0.09% | 0.39% | 2.24% | 4.69% |
| GRINDLAYS CASH PLAN C G | 10.25 | 17-Oct | 0.09% | 0.38% | 2.26% | NA |
| UTI - LIQUID ADVANTAGE G | 1,208.34 | 15-Oct | 0.09% | 0.38% | 2.26% | 4.66% |
| DSP ML LIQ G | 15.85 | 17-Oct | 0.09% | 0.38% | 2.25% | 4.63% |
| LIC LIQUID G | 11.67 | 15-Oct | 0.08% | 0.37% | 2.34% | 5.02% |
Of course, investors need to understand that liquid funds and short-term plans are stop-gap investments to park funds. Investors cannot be invested in them over the long-term.
They need to eventually exit liquid funds/short-term plans when the volatility eases up and a more rewarding investment opportunity emerges. As the table indicates, liquid funds have given investors a positive return over the short-term (1-wk, 1-mth) and haven't fared too badly over the long-term (6-mth, 1-yr) either.
3) Short-term bank deposits will serve the investor's interest just as well. The idea is to not lock your investment in a long-term, 'fixed rate' investment avenue. For instance, say you had to invest in a 1-year fixed deposit that rules at 5.75% p.a. currently.
There is a hike in interest rate a month down the line and banks raise the fixed deposit rate to 6.00%. You would have suffered an opportunity loss of 0.25%.
4) A strict no-no for the debt fund investor is to pick gsec/gilt funds in this environment. Gilts are worst hit in times of debt market volatility as returns from gilt funds will testify.
Gilt funds do their job of providing significant capital appreciation in times of falling interest rates. These times are long gone and investors can give them a miss as is evident from the gilt fund table below.
Gilt Funds: To be avoided
| Long-term Gilt Funds | NAV (Rs) | NAV DATE | 1-Mth | 6-Mth | 1-Yr |
| TATA GILT HIGH INV REG | 12.03 | 15-Oct | -1.44% | -6.64% | -5.66% |
| BOB GILT G | 9.98 | 15-Oct | -2.50% | -7.09% | -5.53% |
| HDFC GILT FUND LT G | 14.61 | 15-Oct | -1.37% | -5.87% | -5.14% |
| TATA GSEC B APP | 21.25 | 15-Oct | -1.27% | -6.13% | -4.82% |
| SAHARA GILT G | 11.25 | 15-Oct | 0.12% | -4.50% | -4.67% |
Admittedly there aren't a whole lot of 'enticing' investment opportunities for the debt fund investor in these times.
He has to get conditioned to first aim for capital preservation and then look for a reasonable return. As the dynamics governing debt markets have changed, his expectations need to change with them.