Debt mutual funds bleeding, what should you do now?The bond market in India has been restless since August 2017 when the benchmark Government of India Bond yield bottomed out at about 6.4%. It now hovers close to 7.4%, a full percentage point rise. Budget 2018 accelerated this trend with a higher than expected fiscal deficit of 3.5% (of GDP) for FY 18. This has cut deep into the returns of debt mutual funds and NPS debt funds over the past one year.

With CPI Inflation at 5%, two of these debt fund categories are giving negative real returns even before tax. If you factor in a tax rate of 30%, all debt fund categories, save credit opportunities, are giving negative real returns. Dynamic bond funds are supposed to avoid this kind of rout because the fund manager has the discretion to alter the portfolio’s maturity to deal with interest rate movements. As a category, they have failed miserably in the past one year.

Fund Category One Year Return (%)
Debt Gilt (Medium and Long Term) 2.65
Debt (Dynamic Bond) 3.90
Debt (Income) 5.15
Debt Gilt (Short Term) 5.76
Debt (Short Term) 6.25
Debt  (Ultra Short Term) 6.43
Debt (Liquid) 6.44
Debt (Credit Opportunities) 7.46

Source: Value Research, Data as on 14/02/2018

Where do you go from here?

The picture is bleak. There is little reason to believe that interest rates will come down again. The pain may get worse rather than better. Just how badly will an individual fund do? Have a look at a figure called ‘Modified Duration’ on the fund page of the AMC website. This figure will tell you the percentage change in the value of a fund’s portfolio caused by a percentage change in the interest rate.

For example a modified duration of three means that a one percent rise in the interest rate will cause the fund’s value to fall by 3%. Categories such as Debt (Income) and Gilt (Medium and Long Term) tend to have Modified Durations of 5 and above. This is why they suffer the most when interest rates rise.

Exiting may be a costly option if you have not completed three years in a debt fund. You will have to pay short-term capital gains tax at your slab rate and you may also have to pay an exit load.

If you have fresh money and wish to invest in a debt fund, consider sticking to just three categories – Debt (Liquid), Debt (Ultra Short Term) and Debt (Short Term). Before choosing an individual debt fund, check its modified duration along with the customary checks about the fund’s past returns, credit quality and fund manager history.

Neil Borate

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