Why debt fund returns are volatile these days?

Debt funds have always been known as the conservative investor’s best friend. They are safer (when compared to equity funds) and usually offer stability to investors. So, when the returns from this category (including the best debt funds) started witnessing volatility, it was sure to cause some arched eyebrows and palpitating hearts. But before you start making panic-struck rash decisions, it is important to understand why are the debt fund returns volatile these days.

Risks in Debt Funds

It is true that debt funds are relatively safer. However, they are not completely risk-free (in fact, no financial instrument is!). Debt Funds have two major risks:

  1. Credit Risk

Credit risk is the risk of default on the part of the borrower to repay the principal loan amount or interest thereon. Credit risk has been on the rise in the country since some time now. Factors such as a slowdown in the real estate sector, the IL&FS fiasco in the year 2018 as well as defaults by big business houses such as DHFL, Zee Group, etc. have contributed to credit risks for the Indian debt funds in the past.

  1. Interest Rate Risk

Bond prices fluctuate as a reaction to changes announced in interest rates. They have the same relationship as the opposite ends of a magnet. One goes up, the other goes down. Whenever there is an increase in the interest rates, the debt fund’s NAV (Net Asset Value) is impacted adversely. 

Reasons for volatility in debt fund returns these days

It is important to understand that debt mutual funds are a part of the overall debt market. Hence, a large-scale credit event or a liquidity crisis is bound to impact the returns of these schemes, even for the best debt funds. 

The month of March (when coronavirus hit our country) witnessed a spike in yields (in the short-term segment) which led to a temporary dip in many debt fund NAVs. This was mainly because of:

  1. Dwindling trade volume and sluggishness in the Indian economy created a sense of panic amongst foreign investors. This led to massive outflows.
  2. Simultaneously, there was an exponential increase in redemptions from the Domestic Institutional Investors as well. 

Lockdown, extreme slowdown of businesses and bank moratorium (wherein borrowers can opt to defer their instalment payments) and tremendous rise in redemptions have increased the chances of default and rendered many papers illiquid.

Is it time to bid adieu to debt funds?

NO. The overall economic situation is in a turmoil. The current volatility in the debt market is a temporary phenomenon and will subdue with resurgence in global and domestic conditions. This category still continues to be one of the preferred investment options. However, what this pandemic and recent volatility in debt markets has taught (or revised our knowledge) is the importance of choosing the right debt fund. Debt funds invest across durations (ranging between one day to more than five years), sectors (corporate bonds, Banking and PSU) and objectives (floater, FMPs credit risk, Gilt, etc). You need to choose the best debt fund as per your risk profile, investment horizon and financial goals, rather than blindly follow recommendations of friends, etc. 

Debt fund investment online and offline

Debt fund investment online is easy, quick and hassle-free. Compared to the offline process, it involves minimal documentation and gets done with a couple of clicks. You can take the help of debt fund investment online portals that are aggregators. They provide relevant information to compare the performance and features of various debt schemes and choose the one which meets your requirements. 

Final Words

RBI has taken numerous initiatives to stimulate demand and revive the bond and money market. Cuts in repo-rates, money infusion into banks through LTRO and supply of forex (USD) to reduce the impact of rupee downfall, will slowly and steadily bring back the debt funds to their former glory. However, all good things take time and hence, patience is of utmost importance. 

Tough times do not last. Tough people (and funds) do. And debt funds are definitely meant to weather these temporary storms and emerge stronger and better in the long run.

Published by Nidhi Mehra

I am blogger with 5 years of experience in writing articles and topics related to finance and funds

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