Debt funds saw strong inflows in August, but should you invest heavily in them?

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Debt mutual funds in India saw healthy fund inflows last month, according to data released by the Mutual Funds Association of India (AMFI). Fixed income funds received a cumulative net amount of Rs 49,164.29 crore in August 2022, making a massive jump of 897% from their previous inflow of Rs 4,930.08 crore in July. Of these, liquid funds amassed the most value, worth Rs 50,095.82 crore.

This also marks a serious turnaround from the Rs 70,213 crore outflow mutual funds witnessed in the second quarter of 2022. For the uninitiated, debt funds generally invest in relatively risk-free instruments by relative to equities, such as corporate and government bonds, debt securities, etc.

Equity funds, however, registered a fall, collecting Rs 6,119.98 crore last month, down slightly from the Rs 8,898.25 crore, which flew last month. Notably, July and August have been tumultuous months for global markets, with major economies like the UK and the US coming to grips with record-breaking inflationary pressures.

Central banks around the world have increased pressure on interest rates, which has diluted and shifted investor sentiment from high-risk equities and emerging markets towards more stable and conservative instruments like debt.

To put that into perspective, major global indices like the S&P 500 and NASDAQ have been in the red over the past month, down 3.39% and 5.78% respectively. Perhaps online, thematic or sector funds in India saw maximum outflows in the equity category, with outflows worth Rs 1,266.67 crore in August.

As Shifali Satsangee, Founder and CEO of Funds Veda, an Agra-based personal finance consultancy, puts it, “Lately, we have witnessed a reversal in the interest rate cycle amid high inflation. and also the pullback in government finances related to Covid stimulus. We expect a few more rate hikes in the future. Thus, it would be prudent to place long-term funds in target maturity products, with a strategy of deployment.

“In fact, we have also seen a significant rise in yields across the yield curve over the past two months. Aggressive central bank rate hikes have naturally made debt funds an investment segment. While this transmission of rates may take months to reflect in the system, debt funds will certainly remain attractive in the months ahead.”

“Moderate return expectations in debt funds”

Viral Bhatt, who runs Money Mantra, a personal finance consultancy in Mumbai, says not to invest heavily in debt funds. “Mutual funds try to maximize returns by investing in all classes of debt securities like bonds, commercial paper, etc. This allows debt funds to generate decent albeit very predictable returns. This also makes them safe avenues for conservative investors, suitable for people who want an investment horizon between 1 and 5 years,” says Bhatt.

Satsangee agrees: “One point to note is to have moderate return expectations in debt funds. These could be ideal for investors who are in higher tax brackets, due to the tax efficiency they offer due to their indexed long-term capital gains tax treatment. The low expense ratios of these funds make them attractive”.

But despite their safety, they also carry risks. “Investors would be exposed to market risks in the interim, as the underlying securities could see changes in capital value, due to short-term interest rate risk. But if investors hold these instruments until maturity, interest rate risk is mitigated.

If you’re someone who isn’t willing to take a lot of risk, play it safe, and trade stability for returns, loan funds are for you. Nema Chahaya Buch, who runs Wishing Tree Financial Advisory, says: “If the priority is to protect the primary investment rather than new returns, debt funds should be preferred. Likewise, if you are in a job or profession that experiences very high income fluctuations, it makes sense to invest more in debt to address these uncertainties. People aged 50 or over should also ideally have more debt to protect their wallets.”

To determine the amount of debt investments in your portfolio, there is a rule of thumb, says financial planner Sanjeev Dawar. “To make it easier to set up, invest in mutual funds in the same proportion as your age. Thus, for a 30-year-old, debt should represent 30% of the portfolio; for a 50-year-old, it may be 50%. This approach brings stability to the portfolio by protecting it from market volatility,” he notes.

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