Interest rate hike worries weigh on banking and PSU debt funds

Concerns on an interest rate hike in the coming months have impacted the flows into the banking and public sector undertaking (PSU) debt funds. Participants in the mutual fund (MF) industry also say that changes in the valuations of perpetual bonds by the Securities and Exchange Borad of India (Sebi) is also one of the reasons for outflows from the banking and PSU debt category.
 
Since the start of the current financial year till July, banking and PSU debt funds have seen outflows of Rs 1,247.44 crore. In the last six months, the category has seen net outflows of over Rs 9,400 crore, shows the data from Association of Mutual Funds in India (Amfi).
 
Mahendra Jajoo, chief investment officer (fixed income) at Mirae Asset AMC says, “Investors are little worried about the interest rates in India. They think rates will inch up going forward, so they are cutting the duration.” 
 
Even the returns generated by the banking and PSU debt funds have come down in the last few months. In the past year, the category has delivered returns of 4.83 per cent, while in the calendar year 2020 and 2019 it had generated returns of 9.83 per cent and 9.78 per cent, respectively.
 
Yields in some of the debt papers under the category have also fallen in the last two years and there are expectations that yields might further go up, impacting their capital values. Market participants say that average maturity of such funds is between one-and-half years to two-and-half years.
 
Typically, banking and PSU debt funds invest 80 per cent of their assets in debt instruments issued by banking, PSUs, and public financial institutions, which makes it a safer investment avenue compared to other debt categories like credit funds and corporate bond funds.
 

Over the last financial year, the banking and PSU category managed to get a fair level of inflows as investors chose to park money into safer options. In the last fiscal, banking and PSU debt funds had seen net inflows of Rs 39,425 crore.
 
Morningstar, in its note on domestic fund flows, stated, “While the flows have been mostly positive in this category through the last 18 months, the last few months (especially February and May 2021) did see net outflows on a consecutive basis. One of the reasons for the outflows was likely the result of the new Sebi norms on the valuation of perpetual bonds like AT1 bonds.” 
 
However, fund managers say that investors who are worried about the volatility in the debt market should move the money to liquid or money market funds. But, if investors want to stay invested for more than three years, they should continue to hold their investments in banking and PSU debt funds.