Why Choosing Debt Funds Over Equity Funds Is Bad For Your Portfolio
Feb 17, 2016

Author: PersonalFN Content & Research Team

Soccer is one of the most exciting team games. Be it a club championship final or UEFA Champions League final, high-voltage games always electrify spectators. But players on field can’t get carried away in the excitement of the game. They always have to play as per the game plan and keep the rules in mind. Every player is given a role and has to do total justice with it, if the team has to win the game. Have you seen any Offense midfield player replacing a Center-back player in the same game? His job is to strike a goal and not defend it. Supposing the attackers and central-forward strikers aren’t playing their roles well, would you replace them with centre back or full back defenders? If any captain does so, that would be disastrous for the team.

When it comes to investing, people seem to be shunning the common sense of not engaging defenders in the role of offenders. The year 2015 wasn’t a good year for equity investors, markets had failed to generate positive returns and meet expectations. Initially, investors ignored the fallacies in the markets and continued buying; however, the protracted lull only increased anxiety levels of the investors.

Looking at the net inflows in income funds (debt funds) of over Rs 15,000 crore in January 2016, it seems that now investors have started going slow on equity funds and have been betting on income funds instead. The weakening of trend in equity and sudden rise in debt fund inflows suggests that investors have been trying to “time” market movements.

Are investors replacing equity funds with debt funds?

(Source: AMFI, PersonalFN Research)
The data indicates that equity markets are losing ground.

But should you be worried?
When poor returns generated by equity funds sadden you, replacing it with debt funds, is probably be the worst thing you could do to your portfolio. If team spirit and well-matched individual roles play a crucial part in a team winning the match; the right portfolio composition is important to generate superior returns.

For mutual funds, there’s no real loss of business. If the inflows in equity funds have started drying up, investors have found a new love interest in debt funds. But from the investor’s perspective, fools go where angels fear to tread.

Conventional wisdom suggests, the right time to invest is when markets are down. You shouldn’t be worried about volatility of markets; rather you should treat the markets’ volatility as an opportunity to do rupee-cost averaging. When you invest regularly, the risk associated with timing the market is eliminated. Those who believe investing in debt funds is risk free or involves lower risk, appear to have their perception slightly misconstrued. True, debt funds are safer than equity funds, but these don’t offer you any protection for your hard-earned capital.

Does replacing equity funds with debt funds make sense at this juncture?
PersonalFN believes it doesn’t; and neither will it make sense in the future. Let’s keep in mind, it is important to have exposure to assets that behave differently under similar market conditions. This evens out risks for you. However, when you completely eliminate or severely undermine the role of any of the asset, it makes your portfolio highly prone to market vagaries. And if your anticipation gets the better of you, there could be a loss on your investments.

In other words, those choosing income funds over equity funds at this juncture may be overlooking risks associated with debt funds. Here’s one of the key rationales, though food inflation is still a worrisome factor, the RBI has been keen on lowering the inflation in other services as well. One case is the Indian banks are rattled with the poor asset quality, and the transmission of rates cuts benefits. There’s an inverse co-ration between interest rates and bond prices. When interest rates climb down, bond prices climb up. Expecting aggressive rate cuts by RBI? That maybe too optimistic!

Speculation is always a blunder. Ideally, check your risk appetite and have an eye on your financial goals. When your investment mix is in line with your goals, investing blunders are most unlikely to make happen.