Most of the time when we talk about mutual funds, it is mostly about equity mutual funds. We often forget about debt mutual funds, that are another interesting segment of the mutual funds. We like debt mutual funds as they can deliver better post-tax return. While debt mutual funds can offer better post-tax return, one needs to choose them well. Just to refresh your memory, I have given types of debt mutual funds (some more info here )
Simple rules for investing in debt funds
Below we try to represent some simple rules to follow when investing in debt mutual funds. The level of bond yields mentioned is based on my debt mutual funds investing experience over the last 10-year. Over a period of time, as India’s rating improves (recently Moody’s upgraded India’s credit rating) bond yields will fall further. For the given credit rating, India’s bond yield is one of the highest globally and hence it is quite rational to expect lower bond yields going forward. In framing our rules, we have assumed that you can invest in debt mutual funds for at least one year. If you are looking to invest for few months, liquid funds are the only option that should be considered.
With this caveat, have a look at below picture:
Which debt fund is suitable in current environment
In the aftermath of demonetisation, lot of cash came back into banking system which was not withdrawn from the banks in subsequent period. As a result, interest rates fell sharply. Long-duration funds did well during this period. However, this is changing as India’s 10-year government bond yield has gone up quite sharply in recent weeks.
As a result, long duration debt funds have suffered. Even dynamic bond funds were caught by the surprise. While bond yields could stabilize around current level, it is quite clear that further rate cuts or sharp fall in bond yields is not that plausible in near-term. Hence it is better to go for liquid and ultra-short term or floating rate funds.
I have some dynamic bond fund and gilt funds in my portfolio. I am switching from these funds into liquid schemes. In last 1-year, liquid funds have delivered around 6.5%. Going forward, if interest rates rise, they can deliver at least 6.5%. Another option could be arbitrage funds which are treated like equity fund from taxation perspective (Equity-arbitrage fund – A tax-efficient option).
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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