Why are investors exiting short-term debt mutual funds?

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In February 2021, investors pulled out Rs 10,286 crore from short-term debt funds, according to industry body AMFI’s data. Investors preferred to jump ship at the first sign of trouble – rising bond yields. Was such hasty selling warranted?

Rising yields spooked investors

After the Budget, the 10-year benchmark g-sec yield shot up to 6.21 percent earlier this month, up from 5.94 percent on January 29. When yields rise, the bond prices fall and so do the net asset values of the debt funds.

Short-term debt funds typically fall less than long-term bond schemes, but the impact was visible. Short-term debt funds’ three-month returns over the past one year showed a drastic decline after January 2021. Since March 4, 2021 the three-month rolling returns turned negative, according to data from ACEMF.

Dwijendra Srivastava, Chief Investment Officer-Debt, Sundaram Mutual Fund says, “Some investors with a short-term timeframe entered bought short duration funds with a view to earn more returns than that offered by liquid funds in a low rate regime, assuming that the yields won’t go up. Such investors are exiting short duration funds as yields move up.”

“While investing in bond funds, most individual investors are keen to make a percentage of extra return than what is available on fixed deposits, which is a fair expectation in a falling interest rate regime. However, when the yields spike, the desire for capital protection makes them sell in a hurry,” says Gautam Kalia, Head-Investment Solutions, Sharekhan.

Will yields move up further?

Although experts claim that interest rates might rise, they aren’t expected to increase sharply. “We are still some time away from the beginning of an interest rate hike cycle,” says Kumaresh Ramakrishnan, CIO-Fixed Income, PGIM India Mutual Fund.

Contraction in liquidity and increased demand for loans in the next financial year may push up the yields marginally. Any increase in inflationary expectations can also cause long-term yields to rise.

Deepak Panjwani, Head-Debt Market, GEPL Capital does not expect the 10-year benchmark bond yield to cross the 6.75 percent mark as he expects the inflation to stay within the limits prescribed by the RBI. “However, if crude prices increase drastically and we do not have a good monsoon, then the inflation will further go up and yields will follow suit,” he adds.

Also read: We must gear up for an interest rate hike this year: R. Sivakumar, Head – Fixed Income, Axis AMC

Should you sell your short duration bond funds?

Hold on to your short-term debt funds, for now. Panjwani advises holding on to your investments till April. After the release of the borrowing calendar and RBI monetary policy meeting in April, the picture will be clearer,” he explains.

But beyond this, ask yourself why you invested in short-term bond funds.

From an asset allocation point of view, short-term funds are among the better schemes to hold on to. Most of them invest in highly-rated securities (though some do take credit risks) and their duration is around three years or less. In other words, if you match your investment horizon with your schemes’ tenures, you can ride out the interest rate volatility.

Joydeep Sen, Corporate Trainer-Debt Market says that an adequate time horizon is necessary to make the most from your debt funds. Srivastava concurs, “Investors should consider actively managed short duration funds with a three-year timeframe to earn healthy post-tax returns. Alternatively, investors can also consider the roll down strategies with a three to four-year timeframe. Long duration bond funds should be avoided,” he adds.

Did you invest in your short-term bond funds because you wanted an extra kicker in returns, over say, liquid funds? If yes, then that is a bad strategy. A liquid fund is a vehicle to park your surplus cash till you find a suitable investment avenue.

Withdrawing from short-term bonds before a year could attract exit loads. And exiting before three years will attract short-term capital gains tax.

The trick to make money in debt funds: match your investment horizon with the scheme’s duration.

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