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I am a 65-year-old Central government pensioner and my wife is a senior consultant for start-up schools. Our children are professionals in their own right. Our health expenses are almost fully subsidised by the CGHS. We have our savings invested in bank fixed deposits, Public Provident Fund and Post Office savings. We have no loans or liabilities.
We have now ventured into mutual funds for the first time. As advised by many, we have selected four debt funds: HDFC High Interest Fund Dynamic Plan, ICICI Pru Long Term Plan, Birla Sun Life Short Term Fund and Birla Sun Life Medium Term Fund (all growth plans only). We may look at equity funds at a later time.
Please advise on whether we can further top-up these four funds.
Jayaram Srinivasan
As a first-time investor in mutual funds, it is important for you to understand that debt funds carry risks. This doesn’t just mean that returns from debt funds can swing sharply from year to year. Debt funds can actually make losses, especially for short periods of up to a year.
After very strong returns of over 11 per cent in the past three years, many income funds have suffered a 4-5 per cent loss on their NAV in the past three months. Medium- to long-term gilt funds, after a 13 per cent plus return for the past three years, have reported a NAV decline of 4-6 per cent in the past threemonths.
So, given that debt mutual funds invest in fixed income securities like government bonds, corporate bonds and money market instruments, how do they end up with NAV losses? These can arise from two factors — credit risk (one of the bond issuers defaulting on repayments or getting downgraded by a rating agency) or interest rate risk (bond prices falling because interest rates in the economy have risen after the bond was issued).
In the past three months, medium/long term gilt funds have made NAV losses because the RBI has refused to cut interest rates further and this has caused market interest rates (yield on the 10 year G-sec) to rise from 6.2 per cent in December 2016 to 6.9 per cent now. When interest rates on new bonds rise, the prices of older bonds held by debt funds fall.
Income funds too have made losses because as government bond rates spike up, the other interest rates in the economy follow suit. In the past week, Taurus Mutual Fund saw four of its debt schemes suffer a 7-12 per cent NAV loss in a single day because a rating agency downgraded one of the bonds they held to default grade. As an investor in debt funds, therefore, it is essential for you to recognise the risk of such losses. Even if such losses prove temporary or fund-specific, you should brace for much lower returns.
Today, if you look back at debt funds for the past three-five years, investing in them would seem a no-brainer because they have delivered past returns of 11-13 per cent. But this is a function of a friendly market and these returns may not be repeated in the next one or three years and will be much closer to your bank deposit rate.
The debt MFs you have selected for your portfolio are some of the top performers in the past three years. Though they are well-managed funds, three of them are also fairly risky. HDFC High Interest Dynamic Plan has managed its high returns by investing in very long-term bonds (its average portfolio maturity is 11 years). ICICI Pru Long Term Plan has again managed high returns through very long-term gilt holdings (its portfolio maturity has swung from 8 to 20 years in the past year). On both these funds, returns will drop if interest rates in the economy rise. The fund managers’ ability to sharply reduce portfolio maturity at such times will also decide returns. Birla Sun Life Medium Term Plan invests nearly half of its portfolio in lower-rated corporate bonds (AA and below).
If there’s a default or downgrade, this can cause a blip in NAV. Birla Short Term Income Fund, of the lot, offers lower risk with the possibility of lower returns.
Having said this, all of these are good debt funds for investors who don’t mind taking on higher risk to earn a higher return over the long term. You only need to decide if you belong to that category of investors.
Send your queries to mf@thehindu.co.in
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