IL&FS crisis: What should you be doing with debt funds now?

The frontline indices have fallen by more than 2per cent in last one week and the broader indices like mid-cap and small-cap have fallen even more. The situation has not yet stabilised and there are chances that it may slip further before it stabilises. One of the factors that spooked the market is the default by one of India’s largest infrastructure financing and developing company, IL&FS. The company defaulted on its inter-corporate deposits and bond repayments. Being like a semi-public owned institution it further aggravates the situation. The credit rating of the company was cut to the lowest category in a span of mere two months, probably in the shortest duration time. Besides, there are other companies too that saw their ratings downgraded.

The repercussion of this is being felt across the equity and debt market. Many mutual funds who hold paper of this company are now caught off-guard. It is estimated that altogether these mutual fund schemes are holding Rs. 2,900 crore worth of bonds of IL&FS and its subsidiaries. Besides, the market is also feeling anxious because of the tight liquidity situation and the banks refusing to lend to NBFCs. All these developments have led to a higher yield for almost all debt funds with different duration.

What Should You Do Now?
We have always advocated that investment in debt funds should be for diversification and not to earn higher returns. Interest rate and credit risk are ian ntegral part of investing in debt funds. If you are aiming for higher returns, be prepared for higher risks.
Nevertheless, the correct approach is to invest in debt funds with a duration that matches your financial goal period. Hence, if you know your goal is to buy a car after three years, you can invest some part of your investment in a debt fund that has a duration of three years. For selecting a right fund you can select those funds that have remained in the top quartile of its category in the last three year period.