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What is your near-term outlook on the debt market? What will be the key triggers from here on?
The regulatory rates and market yields have risen sharply in the past few quarters as Central Banks hiked rates and reduced liquidity. Inflation was stubborn, well outside the comfort zone, which made tightening of financial conditions the need of the hour. Inflation has since cooled down and is no longer threatening to spiral out of control. Central banks are preparing for a long policy pause. In response, bond yields have come down leading to handsome returns in bond funds in the last 2-3 months.
At Trust MF, our view is that inflation is likely to remain benign and could gradually come down further. The interest rate hikes undertaken so far are slowing the economy down and will help keep inflation under control. The bond markets are looking to rally more and will look at inflation trajectory closely before making a decisive move.
Dynamic interest rate scenario and the removal of LTCG appear to have made investors more inclined towards other hybrid products. How can MFDs tackle this?
Hybrid products have been popular with both investors and distributors due to promise of higher returns and better incentive structures for many years now. MFDs should ensure that investors do not end up allocating disproportionate amounts to equities in the garb of hybrid funds. Pure debt funds have many advantages and uses. It would be prudent to divide the portfolio in to three distinct buckets - debt, hybrid, and equities. The importance of fixed income funds in providing safety, liquidity and cost effectiveness to an overall portfolio should be highlighted by the MFDs to their clients.
Debt funds have not performed well over the last three-year period. Many categories of debt funds have delivered returns less than inflation. Why do you think MFDs should continue to recommend debt funds to their clients and justify its worth compared to FDs?
Debt funds perform well when interest rates are trending lower or remain in a narrow range. In the last three years, interest rates rose in line with rising inflation caused by economic normalization and indiscriminate monetary expansion. Debt funds returns were low but positive. Markets are cyclical. Returns are not evenly distributed across time periods. A study of CRISIL Composite Bond Index shows that index has provided a return of 8.50% in the last 10-15 years. While in the short term, returns from debt funds have been subdued, they have beaten inflation quite smartly over long-time horizons.
There is place for both fixed deposits and debt funds in a fixed income portfolio. Fixed deposits give steady returns whereas debt funds can provide liquidity and generate high returns when rates are falling.
Which fund categories of debt funds should MFDs recommend in the current scenario?
The liquid funds, money market funds with maturity below 365 days should be recommended for parking of funds that can be needed at short notice for expenses. These funds are relatively stable in value and provide returns commensurate with prevailing money market rates.
A larger proportion of the portfolio should be allocated to short term funds as it has proven time and again that it delivers across interest cycle if investor remains invested for a period of 2-3 years.
Short term fund variants like banking and PSU debt funds and corporate bond funds can also be considered.
A smaller weightage of funds should be deployed in gilt funds, long duration bond funds which have the potential to generate capital gains when interest rates move down.
How can MFDs make debt funds simpler to their clients? Tell us at least two things that they can do to simplify narrative around debt funds?
When returns from equity funds are subdued for a year, MFDs are likely to advise clients to stay invested or invest more and average the acquisition price. A similar approach should be adopted for debt funds as well. When interest rates rise, prices of bonds fall bringing returns of debt funds down.
In India, interest rates are by and large mean reverting. Investors could be advised to average the purchase price by investing in bond funds when their NAVs are down akin to equity fund investment strategies.
To simplify the narrative, a MFD could highlight that.
1. The volatility of returns is far lower for debt funds compared to pure equity funds and hence greater proportion of the portfolio can be invested in debt funds for optimal liquidity and return combinations.
2. Every once in a while, when interest rates have risen sharply and inflation appears to have peaked out, investing bond funds can deliver high double digit returns for investors in the next few quarters.
MFDs should listen to the advice of 2-3 debt fund managers who explain the markets in simple language and help build debt portfolios for their clients accordingly.
