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    Worried about market volatility and planning to invest in debt mutual funds? Here is what experts have to say

    Worried about market volatility and planning to invest in debt mutual funds? Here is what experts have to say

    Worried about market volatility and planning to invest in debt mutual funds? Here is what experts have to say
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    By Nishtha Pandey   IST (Updated)

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    Experts believe that an increase in interest rates can make investors interested in fixed income products for short-term investments to avoid the sense of unpredictability, and risk and also get good returns. With so much uncertainty, risk factors and volatility let’s understand if debt mutual funds are the correct choice right now?

    The equity market has been a little volatile in the first half of this calendar year. The market has seen adverse effects of the rising inflation and hike in interest rates. With the changes, market investors are also required to work on their portfolios to get maximum benefits.
    Experts believe that the high-interest rates may impact short-term equity mutual funds but long-term equity mutual fund investors are unlikely to be impacted. Last month, the Reserve Bank of India (RBI) hiked the repo rate by 50 basis points to 4.9 percent.
    Experts believe that an increase in interest rates can make investors interested in fixed income products for short-term investments to avoid the sense of unpredictability, and risk and also get good returns. 
    With so much uncertainty, risk factors and volatility let’s understand if debt mutual funds are the correct choice right now?
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    What is a debt mutual fund?
    Debt mutual funds invest in bonds. Banks have increased lending rates, so bond yields increase and the price of bonds will go down. Debt mutual funds will also decrease.
    Debt funds are those mutual fund schemes that invest in fixed income-generating securities. These include Commercial Papers (CP), Certificate of Deposit (CD), Corporate Bonds, T-Bills, government securities, and other money market instruments.
    These instruments have a fixed maturity date and interest rate that the buyers could earn till the maturity of the security. Debt funds are considered to be less volatile than equity funds and are hence ideal for investors who are relatively risk-averse and are looking for stability in their investments. 
    What is the opportunity with a debt mutual fund?
    RBI has already hiked the repo rate to 90 basis points this year and projected inflation now is 6.7, hence, fund selection and timing based on risk profile becomes a key factor while investing. Experts believe that returns from debt funds can bloom. 
    “Presently, yields for AAA rates bonds are ranging from 7.0 percent to 7.5 percent. Therefore, pre-tax returns of debt funds can be expected to range from 6.5 percent to 7.5 percent, depending upon the bond portfolio of the debt fund. However, some debt funds may have bond portfolios with lower yields, resulting in lower returns for investors in the current inflationary environment,” said Puneet Sharma, Chief Executive Officer, Whitespace Alpha. 
    Although debt mutual funds also come with their own risk. Experts advise investors to evaluate credit risk and interest rate risk before investing in debt mutual funds.  
    “Before shifting investments/SIPs from equity funds to debt mutual funds one should consider the interest rate risk, especially given the likelihood of further interest rate increases by RBI in near future,” said Sharma.
    Are debt funds the right choice?
    As interest rates go up, bond yields are going up and bond prices are going down. With this, the yield to maturity of debt mutual funds has also gone up and their return potential has improved. 
    The debt mutual funds are considered to be more stable and, hence, have the potential of generating better returns than equity funds. Rising interest rates and repo rate hikes are instances where investors can take advantage and could generate income by choosing the right debt mutual fund, matching their portfolio’s risk appetite and investment horizon.
    “Floating rate funds or short term duration or roll down maturity funds can earn good returns,” said Viral Bhatt, founder of Money Mantra. 
    A floating rate fund is a fund that invests in financial instruments that pays a variable or floating interest rate. Hence, the interest payment fluctuates with the interest level. Short duration funds are debt mutual funds that invest in debt and money market securities for a period of 1 and 3 years.
    In anticipation of the RBI's rate hikes, bond yields had moved up sharply. As of May 2, the 10-year G-Sec was at 7.12 percent. During this time, the repo rate of the RBI remained at 4 percent. The repo rate has increased by 90 basis points since May 4. Only 25 basis points have been added to the 10-year G-sec - from 7.12 percent to 7.37 percent.
    Although FD rates have risen, they are not expected to give as many returns as debt mutual funds. 
    “Investors can expect 5-6 percent of returns. Three years hold with indexation will give more returns than fixed deposits,” said Bhatt.
    What should investors keep in mind?
    As RBI is likely to increase the repo rates again, which will make the market volatile, debt funds can be a viable option. Experts suggest keeping a mixed portfolio and also suggest keeping a larger part of their portfolio in the shorter-duration funds, like liquid funds and money-market funds, for some time. 
    From a long-term investment point of view, equity SIP investments should be carried on. "However, if the objective is to generate returns for planned expenses in the near future, say 1-2 years, investors can evaluate moving the investments to debt funds," said Sharma. 
    In the current market scenario, investors should stick to their broader asset allocation based on their risk appetite, time horizon, and saving goals.
    “If one has time to follow the market closely and ready to churn the portfolio tactically, one can look at adding to equities and medium to duration bonds in a staggered manner,” said Pankaj Pathak, Fund Manager, Quantum Asset Management. 
    Keep at least 12-24 months of expenses as emergency funds in bank deposits or liquid funds, Pathak said. 
    Investment in debt mutual funds exposes investors to interest rate risks at a time when global inflation is a concern. Thus, this should be kept in mind when considering whether or not to invest.
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