Exiting debt funds to hurt

With returns eroding, retail investors stand to lose. It's better to stick around for the entire tenure

It's almost a sense of helplessness for mutual fund investors. Till now, many were thinking that investing in debt funds would shield them from volatility in equities. But now, even debt funds are in the red.

Returns from income funds are down two per cent in the past month and 0.5 per cent in the last three months. Medium to long-term gilt funds have done worse. The category has seen returns fall 2.5 per cent in the past month and one per cent in the last three months. Similarly, the short-term debt fund category is also sitting on negative returns. It saw a fall of one per cent in the last one month and is flat over the past three months.

The Reserve Bank of India’s (RBI) moves to reduce rupee volatility has seen yields rise sharply and returns falling. Dhruva Chatterji of Morningstar Research says that those who had invested in debt funds in the past couple of months stand to incur significant loss if they try to exit at the moment. “Towards the end of May 2013, one-year bond fund returns were at 13-14 per cent. Today, the one-year trailing returns are down at 3-4 per cent. The erosion has been such that it does not make sense to move out of these funds. Even if one had invested in January this year, bond funds have given an average gain of three per cent, year-to-date (YTD),” he explains.

Long-term debt funds have a tenure of three to five years and short-term ones are for six months to one year.

The only good news is that fixed income experts are of the view that the liquidity tightening is temporary. Says Ramanathan K, executive director and chief investment officer of ING Investment Management: "Liquidity measures are temporary, investors should look at investing in debt funds instead of exiting." Agrees Ganti Murthy, head of fixed income at Peerless Mutual Fund: "Once capital inflows go up, the currency will stabilise and RBI will relax the liquidity measures." So, the advice to investors in long-term bond and income funds is to stay put or at least complete one year of investment. Till then, more clarity will emerge on the liquidity measures. Chatterji adds considering that an interest rate cut has been deferred for now, the market will reposition itself, thus impacting returns. Hence, investors should moderate their expectation of returns from debt funds. But returns will not be as good as it was in 2012. If you are a fixed maturity plan (FMP) investor, it won't matter much to you because if you are holding till maturity you will earn the returns you were locked in at the time of investment. FMPs are not as risky an investment product as actively-managed bond funds, so stay put. Also, it isn't very easy to exit FMP investment as there is little liquidity on the stock exchange platform. Those looking to enter now are advised short-term liquid funds (annual returns = 7.41 per cent) or FMPs. Many of the six months to one-year FMPs were launched recently.