In its latest set of data for the month of March, the Association of Mutual Funds of India (AMFI) has stated that the debt-oriented mutual fund category saw massive outflows of over Rs 1.98 lakh crore against inflows of Rs 63,808.82 crore in February.
As per AMFI data, all debt funds categories witnessed outflow except for long-duration funds, banking, PSU, and Gilt funds with a 10-year constant duration. Among the various debt categories, liquid funds saw the most outflows, with nearly Rs 1.57 lakh crore being withdrawn.
Debt funds are mutual fund schemes that invest in fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, money market instruments, etc., offering capital appreciation. Debt funds are also referred to as Income Funds or Bond Funds.
There are different types of debt funds depending on risk-return profiles, investment horizons, financial goals. Some popular ones are:
Liquid Funds: These funds invest in debt securities with less than 91 days to maturity. They are suitable for investors who want to park temporary cash surpluses for a few days, as they provide steady returns with minimum NAV volatility.
Ultra-short Duration Funds: These funds are suitable for investors with an investment horizon of at least 3 months. These funds earn slightly higher yields than liquid funds and are considered low-risk investments.
Low-Duration Funds: These funds are moderately risky and provide reasonable returns. They are useful for those looking to invest for around 6 months to one year. Their portfolio may include bonds with a weaker credit rating to kick up yields.
Money Market Funds: These funds invest in debt instruments with a maturity of up to one year. They aim to generate returns from interest income, while their slightly longer duration offers some scope for capital gains.
Short-Duration Funds: These funds invest in a judicious combination of short and long-term debt, as well as across credit ratings. These funds are recommended for investment horizons of 1-3 years.
Medium, Medium to Long, and Long Duration Funds: Under normal situations, the portfolio duration of a medium-duration fund has to be between 3-4 years, medium-to-long duration funds between 4-7 years, and long-duration funds greater than 7 years. These funds invest in short and long-term debt securities of the Government, public sector, and private sector companies. They tend to do well when interest rates are falling but underperform when rates are rising.
Fixed Maturity Plans (FMPs): These are closed-end funds that invest in debt securities with maturities that match the terms of the scheme. FMPs typically invest in low-risk, highly-rated debt and hold passively until maturity, when the securities are redeemed and paid out to investors. The main advantage is that the FMP structure eliminates interest rate risk and enables investors to lock in interest rates. The main drawback is that though FMPs are listed, liquidity tends to be low.
Corporate Bond Funds: These funds invest at least 80% of the portfolio in AA+ or higher-rated corporate bonds. Such funds are appropriate for risk-averse investors looking for regular income and the safety of the principal.
Gilt funds: These funds invest exclusively in government securities issued by the Centre and state governments. These are low-risk investments and maturity periods of these securities range from medium to long-term.
Should you invest in debt funds?
Investing in a debt fund allows one to earn interest and capital gains from debt. Retail investors can tap into money markets or wholesale debt markets, which are not directly accessible to them.
Investing in debt funds offers stability compared to stocks, providing a steady income stream. Debt funds earn interest from their investments daily, impacting their net asset value based on interest rates and credit rating changes.
“In March, the entire debt category was negative across with the exception of long duration funds. Usual balance sheet build up in the year-end led to outflows in the liquid ultra-category. Tight liquidity situation led to outflows despite short-term yields peaking led to outflows. Quarterly seasonality of tight liquidity coinciding with the year-end led to even more pronounced outflows,” said Anand Vardarajan, Business Head – Banking, Institutional Clients, Alternate Products and Product Strategy, Tata Asset Management.
Himanshu Srivastava, Associate Director at Morningstar Investment Research India Private Limited, said the outflow in March was due to the advance tax requirements that corporates need to fulfil, especially with it being both quarter-end and financial year-end.
“This trend suggests that investors are anticipating an interest rate cut later in the year, prompting them to reallocate their investments from shorter-duration profiles to longer-duration ones,” Srivastava told CNBC TV18.
At this time, the market is showing higher yields, making it advantageous for investors to enter the debt market. Government bonds offer stability, corporate bonds yield more, and fixed deposits provide secure investment options, creating a positive investment landscape for those capitalizing on market trends.
Besides, the inclusion of Indian government bonds in the two global indices: JP Morgan Government Bond Index-Emerging Markets (GBI-EM) starting June 2024 and Bloomberg Emerging Market Local Currency Government Indices from January 31, 2025, will see more international flows to the bonds. As a result, the demand for the bonds will go up.
Jigar Patel, Member of the Association of Registered Investment Advisers, said: “Mutual funds with higher duration will benefit more. So long-term debt funds and dynamic debt funds that have increased duration in the portfolio are expected to benefit more from the reducing interest rates. Also, long duration G-sec funds will also benefit from decreasing G-sec yield.”