When to invest in a debt fund and how to invest in debt fund is a tricky one. Fixed income can be pretty volatile.
What are the ever green Debt funds? or how to ensure, you are always above the yield-curve? How to earn some extra interest income from debt funds?Are debt funds really safe now? Which debt fund will give best returns? How to choose a debt fund? What is ‘interest rate risk’? What is the safest debt fund? This post is very relevant to July 2020.
After Equity Mutual fund, debt MF has managed to catch the fancy of retail investors. Besides the popular Bharat Bond ETF and liquid mutual fund category, retail NCD issues have also made to our homes very actively in past few years. Especially with higher interest rates compared to Bank Fixed Deposits, it is indeed irresistible.
In this post, I intend to share some factors on debt market investing and how to navigate through it. To achieve the right context, I will use some real life examples to make this topic more relatable.
Bharat Bond ETF Series II IPO is very fresh in our memory with over-subscription, so let’s begin with that. Launched in 14th – 17th July,2020 – the 7 years ETF with 5 years maturity offering 5.46% and 11 years maturity ETF yield is at 6.54%. So, this very safe (almost Government backed) Bond Fund/ Bond ETF is offering a little bit higher interest than SBI Fixed deposit (approximately 5.3% between 5 years – 10 years) So, the interest rate offered by Bharat Bond ETF Does look attractive comparatively and it is.
But, let us assume a scenario, – This is a hypothesis, for explaining how debt instrument works – In 2021, RBI Monetary policy scheduled in the Month of April RBI decides to increase the interest rate by 50 basis point or 0.5% followed by in 2022 April, another 0.5%. Again in April 2023, 0.5%, as a Bank, SBI will have to pass on this rate to the depositors, and the fresh deposit rates are 6.75%. So, a savvy investor is likely to close the deposit now, and book a new deposit with higher interest.
Similarly, this will trickle down in bond market, the new bonds which comes in market, will offer a higher interest rate. So, the bonds issued during low interest regime (we are now in a low interest rate regime) will be sold for higher yielding bonds, and it will cause the bond rates fall, so in this scenario, if anyone sells the ETF unit, likely to earn less interest than the maturity yield or interest income.
In low interest regime, it is a good idea to invest in liquid funds, ultra-short term debt funds. These category funds have no to very low interest rate risk. If someone wish to opt for debt funds replacing savings or fixed deposits, these funds are low risk ones. Because these funds invest in money market instruments, treasury-bills, ultra-short term government securities, so these debt assets have a low maturity and dont get affected by interest rate up or down.
If you want to make a little extra money and ready to study a little more, it is a good idea to check the Banking and PSU funds, check out the secondary bonds in the market. They are the next best options.
If you wish to earn good interest on debt, you should wait for higher interest circle, and buy debt fund or AA+ and AAA rated bonds, if you choose to stay invested for longer term.
In current scenario, of low interest rate, buy debt for shorter terms, and stick to funds like Bharat Bond ETF, liquid funds or Ultra-short term debt fund and review portfolio every quarter.
Yes, unlike equity Mutual Fund, Debt investments like Mutual Funds or Bond should be reviewed every quarter. Debt as an asset category is risky for long term. Unless you are able to lock-in for a really attractive/ high interest rate, investment horizon should not be more than 1 year or should reviewed periodically.
I am not a SEBI registered advisor. This blog is based on my understanding on the subject. This should be interpreted or used for making an investment decision.
