Debt funds bleed in December, returns too collapseAs debt fund returns have collapsed, flows into them also turned negative in December 2017. Income Funds and liquid funds were particularly hit. Whilst advance tax payments by corporates are a regular cause for outflows in December, one cannot ignore the elephant in the room – falling returns.

What happened?

Income funds lost Rs 60,151 crore and liquid funds lost about Rs 1.27 lakh crore in December. In contrast, equity funds recorded modest inflows of  Rs 14,921 crore. This combined effect turned flows into mutual funds negative for the month, after a long streak of large positive flows. Net inflows into mutual funds stood at a negative Rs 1.64 lakh crore.

The returns of income funds have collapsed to about 4.5% for the past 12 months. Liquid fund returns at about 6.5% are also uninspiring. The pain is particularly pronounced in long-term gilt funds with a return of about 1.65% over the past year. This is the direct effect of the government breaching its fiscal deficit target for the year in the 3rd quarter itself, a phenomenon not witnessed since 2009.

The monetary tightening by the US Federal Reserve, ECB and Bank of Japan has also contributed to rising yields and hence lower debt fund returns. Bloomberg reports that surplus cash with banks, the biggest holders of rupee sovereign (government) debt, is also down from Rs 5 lakh crore in March to about Rs 70,000 crore at present.

Nowhere to hide

Debt fund investors who have invested within the last three years will have to pay short-term capital gains tax at their applicable tax slab if they redeem their debt funds. They will also be deprived of the benefit of indexation. Investments older than three years will face a lower rate of long-term capital gains tax at 20% and get the benefit of indexation. However, some tax outgo will be unavoidable for these investors as well, if they redeem their investments.

There is also little relief for debt fund investors who are risk averse and do not want to shift to equity funds. Bank FD rates have plunged to below 7% and rates on schemes such as National Savings Certificates and Kisan Vikas Patra are following suit. The legendary 8% RBI taxable bond is no longer 8%, as we explain here.

Is this the start of something bigger?

The jury is out on that. The debt fund outflows may quieten down in the following months. The approaching budget of February 1st can also have a major impact on how this story unfolds. However, some of the other fundamental factors such as the global monetary tightening are unlikely to reverse course.

Any solutions?

Among the different categories of debt funds, liquid funds, despite their outflows carry the lowest interest rate risk. Ultra short and short-term funds are also reasonably low-risk alternatives. Those seeking to deploy fresh money can seek refuge in these categories. As for those who have already invested, the damage is already done.

Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at