Most of our readers, who invest in mutual funds, have exposure (some large, some full) to debt funds in their portfolios. And rightly so, given that debt funds make great investment sense in a falling interest rate environment. But now that the interest rate environment may be changing, the question is how should you restructure your investments?
That a correction was due in the debt markets was widely anticipated. Actually this anticipation has been there for quite some time now. In fact, we at Personalfn carried an article on our website discussing why the downward trend in the interest rate cycle maybe turning as early as December 2002:
The sharp correction in the debt markets, which has unfolded over the last fortnight, has taken most investors by surprise. Losses, in some cases, have exceeded 2% during this period (over 60% on an annualized basis).
| Income Funds (Long Term) |
NAV (Rs) |
1-Wk |
1-Mth |
6-Mth |
1-Yr |
3-Yr |
Incep. |
| PRU ICICI FLEXI INC PLAN |
10.3 |
-4.1% |
-5.4% |
NA |
NA |
NA |
2.8% |
| GRINDLAYS DYNAMIC BOND |
10.7 |
-2.0% |
-3.2% |
5.3% |
NA |
NA |
7.0% |
| RELIANCE INC GR |
18.4 |
-1.9% |
-2.8% |
5.5% |
9.8% |
12.4% |
12.8% |
| JM INCOME G |
23.9 |
-1.7% |
-2.6% |
6.0% |
11.2% |
14.0% |
12.1% |
| PNB DEBT FUND (G) |
17.7 |
-1.7% |
-2.2% |
7.4% |
13.0% |
18.3% |
16.9% |
| K BOND DEP G |
15.1 |
-1.6% |
-2.4% |
5.9% |
11.2% |
13.1% |
13.6% |
| GRINDLAYS SP SAV G |
14.1 |
-1.5% |
-2.5% |
6.2% |
10.8% |
NA |
15.0% |
| K BOND WHOLE G |
15.4 |
-1.5% |
-2.4% |
6.2% |
11.7% |
13.7% |
14.3% |
| HDFC INCOME G |
14.1 |
-1.2% |
-2.0% |
6.6% |
11.8% |
NA |
14.9% |
| TEMPLETON IBA MB |
19.2 |
-1.2% |
-2.9% |
6.5% |
NA |
NA |
10.3% |
However, there are some funds, which have done noticeably well:
| Income Funds (Long Term) |
NAV (Rs) |
1-Wk |
1-Mth |
6-Mth |
1-Yr |
3-Yr |
Incep. |
| UTI VARIABLE INV. LP |
10.1 |
0.6% |
-1.5% |
NA |
NA |
NA |
0.4% |
| TEMPLETON FLOAT LTP G |
10.8 |
0.1% |
0.4% |
3.4% |
7.4% |
NA |
7.2% |
| HDFC FLOATING LTP G |
10.0 |
0.1% |
NA |
NA |
NA |
NA |
0.2% |
Some of these funds which have performed relatively well were the focus of our article
Now, coming to the main issue – What should you do now?
The general view is that interest rates are unlikely to decline significantly from the present level. In fact, some even believe that there might be an uptick in interest rates in the near term. Simply put, there is a lot of uncertainty.
In such an environment, which is overcast by uncertainty, investors need to ensure that:
-
They are well diversified in their investments i.e. exposure to debt funds is reasonable. (Read our article: Don’t only blame the markets for your losses?)
-
And a part of the money that has been reserved for debt mutual funds is invested in schemes that can be termed as hybrids. These ‘hybrids’ will minimise risk in a volatile interest rate environment.
Let’s discuss a little more about these hybrids (in the debt space). Generally speaking, these hybrids can work in two ways:
-
They invest in instruments that offer a floating rate i.e. if interest rates rise, the coupon rate of the instrument too rises and vice versa. Since the interest rate is reset regularly, the price impact of the change in interest rate is negligible. Therefore, funds that invest in such schemes are unlikely to incur a significant capital loss. Eg. Templeton Floating Rate Fund, HDFC Floating Rate Fund.
-
Another way in which these hybrids work is that they restructure themselves by changing the maturity profile of their portfolio. For example, in a declining interest rate environment, such a hybrid would invest in long term paper (which benefits the most from a decline in interest rates). However, if interest rates were to rise, or show signs of rising, such a fund would invest in very short term paper (like a liquid fund) so that the price impact is minimal. Eg. Grindlay’s Dynamic Fund, Sundaram Dynamic Fund, UTI Variable Income.
Such hybrids as is evident are compelling investments in such an environment.
However, at the same time, investors need to be aware that income/gilt funds do still make investment sense if one is looking at investing for time periods in excess of one year.
If you are in Mumbai and need help in planning your finances, <a data-cke-saved-href="https://www.personalfn.com/investment/mumbaientry.asp style=" href="https://www.personalfn.com/investment/mumbaientry.asp style=" color:blue"="">give us a try. We are experienced and qualified and are in a position to meet your requirements.
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