Make a smart move, invest in short-term debt fund

Debt funds are funds which invest in debt securities. These are also known as fixed income securities as they provide fixed returns with periodic payments. Debt securities include Certificate of Deposit, Commercial Papers, Corporate bonds, Government bonds (Gilts) etc.

The issuer of these securities or bonds, that is, government or businesses pays interest at a specified coupon rate on specified intervals. The principle amount of the investor is repaid at maturity date. Thus, the NAV (Net Asset Value) for the debt mutual funds are calculated as sum of coupon payments that is interest accrued and the price of the bond. The rate of return on these fixed income securities is stated as the 'Yield'. Yield is nothing, but the ratio of interest received on these securities and the buying price of the same.

The debt funds are preferred by the risk-averse or conservative investors who expect steady income and want to stay away from the market volatility. The returns from these funds are affected by various factors like interest rate volatility, fluctuation in currency, current account deficit and credit risk.

The prices of these securities are governed by interest rates in the market. Prices are inversely proportional to the interest rates, that is, if interest rates fall. The prices of these securities will rise vice versa, if interest rates rise the prices of the securities will fall. However, the yield from these funds share direct relation with the interest rates.

Recently, on December 2, 2017, RBI’s monetary policy committee has kept the interest rates unchanged noting the inflation risk. Also, it has maintained its neutral policy stance which indicates that rate direction in the future will be based on the data and will be in either direction. Further, the recent hike in crude oil prices coupled with the inflation suggest a possibility of interest rate hike in the coming years. However, it is not a conclusive statement as RBI’s stance in December suggest stability or reduction in interest rates.

The dilemma in the interest rate scenario will be a concern for the debt funds investors in the near term. The debt market is already anticipating a rate hike of around 30-40bps and is being discounted in the current yield curve. Thus, keeping this in mind one should not invest in long-term debt funds until there is clarity about the interest rate and future trajectory of bond yields.

However, in the current market scenario, investors are advised to prefer short-term debt schemes to keep their investments safe. However, investors already holding the long-term schemes should hold it as if interest rates fall or remain stagnant then the investor can be benefit with the returns as well as can avoid long-term capital gain tax.