Tuesday, August 27, 2013

Debt Mutual Funds and Capital Safety

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THE recent movements in the debt market have caused a lot of panic among investors as they have found that several of their plans have come unstuck. This has happened as the liquidity squeeze in the debt markets have ensured that the yields have gone upwards, which has played havoc with the net asset value (NAV) of debt oriented funds. Here is a look at the issue and how the investors can ensure that they are able to tackle the issue in an effective manner.

Change of trend:

One of the biggest impacts that the liquidity squeeze has on the investment climate in debt oriented funds is that the trend that was prevalent earlier has completely changed. An expectation of a rate cut in the coming days which would accelerate and then lead to a fall in yields was the reason why a lot of investors were looking at long-term debt funds like income funds and gilt funds. The situation has turned in the sense that the yields are actually rising and in the very near term, the expectation of a rate has all but gone. This is important because the overall base for the entire decision making now needs to be geared to a position where there might not be any rate cuts and hence this should be the guiding force.

Debt can lose:

For all those who were thinking that it is only the equity oriented funds that can end up with losses for their investors, the past couple of weeks have come as a rude shock. The fall in the long-term debt funds on the day when RBI initially applied the liquidity squeeze was anywhere between 3-5 per cent which is a huge sum, and this might not even be seen in several equity oriented funds. This has sent returns for several investors crashing and for those who entered in recent times there is actually a loss on the portfolio.

The bottom line is that debt can actually end up with losses for an investor because unlike steady normal debt, the instruments that are held by the mutual funds are actually traded and hence these are subject to fluctuations.

This means that there can be a capital loss on these investments, which will mean a reduction in the net asset value of the fund. Investors need to keep this in mind when they are looking at their investments and hence this becomes a crucial factor whenever they are making their investment choices.

Risk and return:

The way to go about choosing a debt fund is that the investor would have to look at the time horizon that they want to put their money for. This will require them to decide the exact period for which they need to remain invested because the choice of the fund depends only on this factor.


The nature of the fund that is chosen right from a liquid fund to a short term fund or even a long term income fund depends on this factor.

The risk element needs also to be brought into the picture because if the appetite of the investor is for taking some risk, then they should venture into long-term funds including gilt funds. If this is something that the investor does not want to do then they need to ensure that they stick to lower risk funds. Here the risk would be low but they should also not expect very high returns. When this is matched with the time period then it should match appropriately. This is important so that the entire investment structure is created properly.

Happy Investing!!

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