Debt funds provide stability to your portfolio. Their returns are not expected to fluctuate much. You get better returns than keeping money in the bank and if you hold these debt funds for 3 years then you get the added benefit of claiming tax indexation on your capital returns.
Moreover, debt funds also provide the flexibility of partial withdrawals. We can withdraw any amount anytime without any penalties that we would have to pay in breaking an FD. That is why we have always felt that this is a “Better than FD” product. Many investors have thus used them to achieve the right asset allocation for their portfolio.
Debt fund growth rates dropped. But why?
This month we saw that debt fund returns were eroded. Even funds like Ultra Short term and Liquid funds were losing money. Now, these funds only invest in securities which would be maturing in a short time, so their returns are not very sensitive to interest rate movements.
Moreover, World over, the central banks are cutting rates and our hope was that the RBI governor would follow suit (he cut the rates by 75 basis points today). When interest rates fall, bond prices go up. So why were these bond prices falling making the NAV of my Debt Mutual Funds go down?
Well, the answer to that is slightly technical but not too difficult to understand. March is the month for paying taxes. So a lot of companies, who hold their cash surplus in fixed income securities or bonds, sell those to pay their taxes.
Think of liquidity squeeze as having a market where far too many people are trying to sell and too few willing to buy. This buyer’s market caused bond prices to fall.
The COVID-19 crisis across the world also spooked some Foreign Portfolio Investors who invest in Indian bonds. So, they also wanted to sell and take their money out. These two combined factors created a liquidity squeeze. Think of liquidity squeeze as having a market where far too many people are trying to sell and too few willing to buy. This buyer’s market caused bond prices to fall.
So what's the best thing to do?
So what’s the best thing to do with Debt fund investments? The short answer is “nothing”. Selling debt funds in this squeezed market would be like selling your assets in a stress sale and selling your assets in a stressed market is the worst thing to do. Investors would have got the worst price. We all know that. Right?
RBI makes a move
We were expecting the RBI governor to step in and provide liquidity and rate cuts. The RBI governor did just that today. He declared a string of measures like cutting the Repo and the reverse repo rates, cutting the Cash Reserve Ratio (CRR) by 100 basis points, injecting liquidity of Rs 3.74 lakh crores in the system etc. All this should cause the interest rates to go down (and hence bond prices to go up). At the time of writing this piece, the interest rates were indeed down.
So what would we do next? Well, the best thing would be to continue to do what we were doing and not worry about debt fund bond prices.
Stay safe and Stay invested.