The last few years have been tough for debt mutual funds. This is primarily because of high inflation, which prompted the Reserve Bank of India to hike interest rates. A hike in interest rates meant low returns from debt funds (note that interest rates and returns move in opposite directions). While inflation remains sticky and India’s central bank is likely to increase rates further, signs of revival in debt funds are visible. Simply put, they are slowly staging a comeback after some challenging years.
So, what are signs of debt mutual funds gaining ground and the reasons that make them apt to invest business cash.
Signs of Debt Mutual Funds Making a Comeback
- Things are Stabilising Slowly
While inflation is still a matter of concern and is above the comfort level of the Reserve Bank of India, it’s believed that the worst is behind us. It’s true the interest rates have seen a continuous uptick for several months now and are expected to go up again, but they are unlikely to go up substantially.
Also, the RBI has been cautious, balancing the need to control inflation while ensuring that the economic recovery remains on track. The central bank has also been implementing measures to improve liquidity and credit availability, which has helped support growth in several sectors.
This would benefit debt funds as their underlying bonds are less likely to be impacted by an adverse rate movement. The interest rate cycle is likely to peak out in the next few months, making debt funds attractive.
- Yield to Maturity Moving Up
Another indication of debt mutual funds staging a comeback is the rise in yield to maturity or YTM. YTM is the return received when you purchase a bond and hold it till maturity. The yield on a three-year AAA-rated corporate bond has moved up from 4.7% in October 2020 to 7.9% in March 2023. During the same period, the yield on a five-year AAA-rated corporate bond fund has gone up from 5.6% to 7.8%.
The benchmark 10-year G-sec is trading around 7.35%, from below 6% at the beginning of the current rate hike cycle. The rise in YTM presents an excellent investment opportunity in debt funds. It is anticipated that the returns going forward are likely to be equal to or higher than the prevailing YTMs.
Reasons for Business Owners to Invest in Debt Funds Now
- Chances of Earning Better Returns
Idle business cash investment in debt mutual funds can now fetch better returns for corporates. Gross portfolio yields across debt fund categories have increased by almost 200 bps in the last 18 to 24 months. Given that yields are inching up, investing in debt funds, particularly liquid and ultra-low duration funds, can fetch decent returns on investment.
- Tax Only on Redemption
While removing LTCG benefits has brought debt funds with FDs as far as taxation is concerned, note that debt funds are taxed only upon redemption, unlike FDs that are taxed on an accrual basis. Additionally, debt funds allow business owners to withdraw money anytime needed without paying any penalty, unlike FDs, where a penalty is charged if you break the FD before its tenure.
- Multiple Options at Disposal
As a corporate, you can choose to invest in debt funds based on your investment horizon. To put it otherwise, you can select a particular type of fund based on your need and the time you wish to remain invested (see image).
Prudent Investment Strategy in Debt Funds Now
With all indications of debt funds staging a comeback, it’s essential not to get carried away and invest with prudence. Investing company money in ultra low duration funds is better than long-duration funds as the latter takes a massive hit in the event of a spike in interest rates.
Investing through a combination of ultra low duration funds and maturity debt funds can also be an option to explore. The former is less prone to interest rate risks and provides quick liquidity, making them suitable for meeting short-term financial obligations.
On the other hand, maturity debt funds provide higher returns in the long run and are more stable. By combining both types of funds, business owners can benefit from a balanced investment portfolio that offers liquidity, safety, and steady returns. Apart from analysing debt mutual funds’ returns and duration, it’s equally essential to ensure that the fund holds high-quality bonds rated AA or above. High-quality bonds lower chances of default.
The Final Word
Key indicators suggest that debt mutual funds present a strong case for consideration. If you are looking to invest in debt mutual funds, look no further than Shootih – India’s First Business Wealth Management Platform.
With this mutual fund investment platform for corporates, you can invest in various debt mutual funds as per your choice, risk appetite, and investment duration. To schedule a product demo with our expert, click here.
Disclaimer: Mutual fund investments are subject to market risks, please read all scheme-related documents carefully
The content of this blog is not intended to serve any professional advice or guidance and Shootih takes no responsibility or liability in whatsoever manner for any investment decisions made by the readers of this blog or other blogs. Readers should seek independent professional advice before making any investment decision based on the information provided on this website.
