Investors pull out big money from debt funds despite attractive yields

Fund managers and MF distributors expect net inflows to turn positive after completion of rate hike cycle

Money continues to flow out of debt mutual fund (MF) schemes despite the fact that interest rate hikes have been boosting their future return potential. In October alone, investors pulled out over Rs 1,500 crore from each of corporate bond funds and banking & PSU funds, the two of the most-popular debt funds among retail investors.

Fund managers and MF distributors say investments in debt funds are expected to gain pace only after the rate hike cycle is complete and these schemes have better performances to show in the return charts.

"Debt funds have just about stabilised. Money is likely to start flowing in after a couple of months," said Mahendra Jajoo, chief investment officer (debt), at Mirae Asset Investment Managers.

During the past one year, corporate and banking & PSU funds have together seen a net outflow of Rs 95,000 crore. Among other popular schemes, Rs 48,000 crore has flowed out of short duration funds and Rs 1,750 crore from gilt funds between November 2021 to October 2022, shows an analysis of data from the Association of Mutual Funds in India (Amfi).

Money started flowing out of medium-to-long duration debt funds early in the financial year 2022. The outflow has continued since then as low interest rates and the ensuing rate hikes pulled down the performances of debt funds.

However, now that most of the rate hike has already happened, debt funds are in a state where they can deliver much better returns going forward.  The yield-to-maturity (YTM) of shorter-duration funds have reached 6-7 per cent, while they are at 7-8 per cent for longer-duration funds, according to Value Research data. This indicates that they are set to deliver better returns compared to other fixed income investment options like bank fixed deposits.

According to fund managers and mutual fund distributors, this future return potential is not enough to regain the attention of retail investors. They expect higher inflows only after debt funds have better performances to show.

"Investors would like to see better returns, at least in the near term. Not all investors can evaluate the future return expectations," said Parijat Agrawal, Head - Fixed Income at Union Asset Management Company.

MF distributors have started recommending debt funds to their clients but are sticking only to shorter maturity funds as they wait for the rate hike cycle to complete.

"I am not recommending medium-to-longer duration funds as more rate hikes are expected. The interest rate is expected to peak in the first half of 2023 and that may be the perfect time to relook at medium-to-long duration funds," said Rushabh Desai, founder of Rupee With Rushabh Investment Services.

"People are apprehensive as rate hikes are not yet over. Poor returns in the last 1-2 year period is also acting as a dissuading factor," said Nitesh Buddhadev, founder of Nimit Consultancy.

There are other factors too. In the last couple of years, debt funds have seen the emergence of new competitors in platforms that deliver better returns through products like peer-to-peer (P2P) loans, invoice discounting and corporate debt. These platforms have tied up with MF distributors and insurance agents in the recent past to expand their market.

"P2P has gained traction in the last few years amid a poor outlook of debt funds and the thrust provided by MF distributors," Buddhadev said.  

According to MF executives and distributors, inflows in debt funds is also a factor of extra cash with people. Rising inflation and equated monthly instalments (EMIs) especially of home loans have taken a toll on savings this year.