Explained: Debt funds see outflows in August on interest rate uncertainty

After witnessing robust net inflows of Rs 61,400.08 crore in July, debt mutual funds faced substantial outflows totalling Rs 25,872 crore in August, with nine of 16 debt fund categories experiencing outflows during the month.

The major quantum of net outflows was witnessed by the categories having less than one year duration profile such as Liquid, Ultrashort and Low duration.

"The mutual fund industry witnessed outflows from liquid and ultra short duration funds due to institutions pulling out money primarily to fund investment cycles. There is also a cautious outlook amongst investors on the future interest rate scenario. The data correlation also suggests there might have been some reallocation of funds from conservative to aggressive as liquid funds saw a 5-month high in outflows and equity funds saw a 5-month high in inflows," said - Mayank Bhatnagar, Co-founder & COO, FinEdge.

The banking and PSU category also witnessed significant net outflows, according to an analysis by Morning Star India.

"Given the current interest rate scenario and uncertainty over the direction of interest rates in the country, it appears that many investors continue to adopt a cautious stance. They are waiting for further indications on interest rate to make an investment decision. Also, a rally in the equity markets could have also prompted investors to shift their focus from debt to equity," said Melvyn Santarita, Analyst - Manager Research, Morningstar India.

In the case of liquid funds, it's important to note that a significant portion of investments comes from institutional sources, often for very short durations.

"The movement of funds in and out of these funds doesn't typically follow specific reasons in the traditional sense, as they serve as a temporary parking place for funds," said Santarita.

The quantum of these flows, both inflows and outflows, tends to be relatively high due to the nature of these funds.

In  August 2023, the overall liquidity in the market was very tight. Therefore, many corporates redeemed some units held in liquid mutual funds to meet their working capital requirements. "Similarly banks also partially redeemed from liquid mutual funds to comply with the RBI's temporary incremental CRR requirement. As a result, we saw a net outflow from liquid mutual funds in August. However, banks and corporates should again park their surplus funds in these liquid funds once the liquidity improves," said Anshul Gupta, Co-Founder and Chief Investment Officer, Wint Wealth.

However, a section of investors were willing. Anticipating a change in the interest rate cycle, a section of investors invested in categories like Gilt Funds, Dynamic Bond Funds, and Long Duration Funds, which stand to benefit if the interest rate cycle reverses.

"As and when there is more clarity on the start of the interest rate cut cycle, these categories may witness enhanced flows. These funds carry relatively high interest rate risks and hence investors should bear that in mind while taking exposure in them," cautioned Santarita.

Floater Funds continue to attract investors

Floater funds are debt funds that invest at least 65% of their money in floating-rate bonds. The interest rate offered by the instrument changes as per the fluctuations in the interest rate of their benchmarks. It is generally seen that as the interest rates increase in the debt market, the interest rate of these floating interest instruments rises too, and the floater funds deliver higher returns.

Floater Funds continued to attract investors with the category receiving net inflow of Rs 2,325 crore. This could be attributed to their ability to re-adjust based on the prevailing interest rate scenario. 

Categories which take credit bets such as Credit Risk and Medium Duration struggled to attract investors during the month