What should be your investment strategy for debt funds amid rising rates?

Consumer Price Index (CPI) data shows that retail inflation soared to a five-month-high level of 7.41 per cent in September. Since the Reserve Bank of India (RBI) has been raising the repo rate in the high inflationary situation to control inflation, the repo rate has been increased by 190 bps till now including the last 50 basis point (bps) hike taking it to 5.90 per cent. Since debt mutual fund schemes invest in fixed-income securities, rising repo rates and bond yields have an effect on the net asset value (NAV), particularly for long-term bond funds. A hike in interest rates is anticipated at the upcoming MPC meeting of the RBI, which will be held in December, as the yield on the 10-year Indian government bond climbed to 7.5% in October, the highest level in the previous four months. What investment approach should investors use for debt funds in light of the unpredictable market situation, where debt is thought to be less turbulent than equity?

Mr. Sandeep Bagla, CEO, TRUST MF said “In September, the system liquidity had turned tight due to high unspent government balances and FPI outflows from equity markets. Additionally, markets anticipated repo rate hikes by RBI and market yields went up as a consequence. In an environment of high uncertainty and volatility, debt flows witnessed net outflows as the returns had turned subdued.”

He further added that “RBI is expected to hike the repo rates by another 60 bps in the coming policies, which could create some amount of volatility in the markets again. Domestic inflation remains high and may come down due to the base effect in the next quarter. We at TRUST MF feel that inflation due to high food prices, international commodities and high domestic wage pressures could remain high for longer. We are recommending to our investors to stay invested in funds with maturities lower than 2-3 years as one is able to generate higher than 7% return without taking interest rate risk.”

“The ideal allocation for the retail investor could be 30% in Liquid/Money market fund 60% in Short term fund/BPSU debt fund and 10 % in Long maturity funds. We prefer to advise investors to remain underweight at the longer end of the curve. While yields have reason already to 7.50%, it is possible that yields climb higher if domestic inflation remains high,” said Mr. Sandeep Bagla.

The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.