Source: The Economic Times.
Several developments have taken place in debt mutual funds (MFs) of late. The impact of sharp movements in interest rates and high inflation rate is being felt on the debt market, which, in turn, is affecting investors' decision-making process. Hence, investors should make sure they adopt the right strategy for debt-oriented funds. Debt-oriented MFs invest their corpus in various debt instruments. The movement in net asset value (NAV) of the fund takes place according to the impact on the price of debt instruments. Investors should distinguish these instruments from equity-oriented schemes as well as stocks that are listed on the stock exchange because the features and price movements of these instruments differ. There is a clear relationship between the change in interest rates and the change in price of a debt instrument - like a government security or a corporate bond. When the interest rate rises, there's a fall in the value of the security, which leads to a fall in the NAV of the fund that holds the security. On the other hand, a fall in interest rate will lead to a rise in the price of the debt security and a rise in the NAV of the fund holding the security. Several debt-oriented schemes are present in the market - these range from short-term liquid schemes to gilt funds that have long-term government securities in their portfolio. Let's take a look at what should be the strategy. If investors have money to spare, they should invest it in liquid and short-term schemes, since there is a liquidity crunch in the short-term market. This increases the chances that on days there's a sudden shortage of funds, there will be a spike in the overnight rates, which will benefit liquid and short-term schemes. This can be useful for investors as their short-term money can generate earnings, rather than simply lying around. Meanwhile, no further investments should be made in schemes which invest in medium to long-term instruments. Any further hike in interest rates will have a negative impact on these schemes. This leaves us with schemes like floating rate and MIPs. Floating rate funds can cope with this situation better than income or gilt funds, but investors should not expect too much. There's always some time before floating rate funds feel the impact of a change in interest rate on their holdings. MIPs could also face a tough time as their performance, to a large extent, depends upon that of the equity market. Till it continues booming and the debt market is in a turmoil, these schemes carry greater risk. The only clear winner here is fixed maturity plans that will see a rise in earnings. Since these are close-ended schemes providing high returns, they will be a hit among investors.
Take Your Pick
- There is a clear relationship between change in rates & change in price of debt instrument
- If you have money to spare, invest it in liquid and short-term schemes, since there is a liquidity crunch in the short-term market
- There's always some time before floating rate funds feel the impact of a change in interest rate on their holdings
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