Debt fund returns came under pressure during the last few months. While long duration funds such as income funds and gilt funds delivered negative returns due to sharp rise in long-term bond yields, stressed liquidity conditions affected performance of funds on the short end of the curve.
Let us see what experts have to say about this decline.
Sharp rise in yields
“Rising crude prices, strengthening dollar and higher than expected retail inflation numbers are pushing up long-term bond yields,” believes Vidya Bala, Head of mutual fund research, Fundsindia.
“Though RBI has left the key policy rates unchanged, the policy minutes reflect a hawkish stance. This foretells a near-term rate hike,” said Joydeep Sen of Wiseinvestor.
Bond price and yield share an inverse relation. Thus, the spike in yields has resulted in decrease in price of long-term debt securities. Hence, long-term debt funds have posted negative returns.
Tight liquidity scenario
Talking about increased volatility in shorter-term debt market Dwijendra Srivastava, Chief Investment Officer (Debt), Sundaram said, “The current tight liquidity conditions have caused yields to harden. With RBI enforcing strict Prompt Corrective Action (PCA) norms on stressed public sector banks, the issue of new credit by these banks has come to a standstill. Moreover, increasing US bond yields have caused foreign investors to exit Indian markets in favour of US. This has put additional liquidity pressure on the short-term market.”
Currently, government spending is unable to fill the void left by lower loan issue and foreign portfolio investors exiting markets. Thus, in the near term, markets may face some volatility. However, short-term funds are expected to be less volatile compared to long-term funds.
High yields indicate that markets may have discounted many negatives
“The current 4-5 year bond yields indicate that markets have already factored in a 0.75% rate hike. Going forward market participants will closely track RBI policy in June for further cues,” says Kirtan Shah, COO StreetsAhead.
“The markets have risen very sharply in the last few months. However, with 10 year G-sec yields at 1.9% over repo and short-to-medium term AAA corporate bond yields 2.25%-2.5% over repo, markets seems to have discounted a lot of negatives,” said Avnish Jain, Head Fixed Income, Canara Robeco.
What should advisors do?
At these elevated yields, debt markets provide an attractive entry point for investments. Advisors should recommend short duration funds for their clients having investment horizon greater than three years. A key advantage of recommending short-term funds is that they are less volatile compared to long –term funds. Furthermore, to mitigate risk, advisors should recommend that their clients spread the investment over the coming months as FY 2019 is expected to be a volatile year.
In addition, many investors invest in debt funds assuming they are risk-free products. This myth gets shattered during such a downturn. Advisors should view this as a chance to sensitise investors towards debt fund risks.