How to Deal with Negative Returns in Debt Funds?

Debt funds are the popular investment choice for risk-averse investors looking for low risk and reasonable returns. This is because debt funds are less volatile in comparison to equity funds. 

Though such reasoning may hold good over the long term, short-term investments in debt funds can still negatively affect returns. You might know that debt funds have nothing to do with equities, and they only invest in instruments, such as money market instruments, government securities, and private sector bonds. 

Irrespective of where the capital is invested, most of the debt funds’ average returns in 2021 have been negative so far. A few debt fund products are on the negative side of returns consecutively for more than three months.

Cause for Negative Returns

The rise in inflation could be a reason for the negative growth in debt fund returns. Globally, the yields in debt funds have raised concerns with the increasing commodity prices. This may further lead to higher inflation forcing the central banks of countries to increase interest rates.

Falling bond prices result from investors dumping the existing bonds they hold for a high-interest rate in the upcoming bonds. Since the government falls short of funds, it borrows from the market to fill the gap. The more the government borrows, the higher the yield grows.

Debt funds that are only into government securities are called Gilt funds. It is noticed that the net asset value (NAV) of Gilt funds and Gilt funds with a 10-year constant duration are the two main categories of debt funds that have seen a greater fall in the short term. 

Within the past month, yields of 10-year bonds have moved up by 30 basis points. While the 15-year bonds have moved up by 40 basis points, the two to five-year bonds have been moving up by 50-80 basis points. 

Since the benchmark for holding Gilt funds is 11 years, those holding any positions could encounter losses. With the yield curve moving up, there has been a steep fall in Gilt funds.

Strategy to Deal with Negative Returns

Investment advisors suggest investors stick to the asset allocation structure and wait until the volatility phase in different asset classes is over. Changing asset allocation during the volatility phase can be a wrong decision as all asset classes go through ups and downs. 

On the other hand, if the yield curves continue to increase, it is advised to shift funds within the debt fund category. If you need the money within the next six months to one year, you can redeem from high duration products and reinvest in low duration products. If you are looking to realise goals over the next three years, you can choose the low duration and money market category. This can be the case for first-time investors as well.

Industry experts expect that the interest rates may go up. Therefore, long-duration funds are not recommended. Further, you need to consider a good portfolio and avoid funds from taking credit calls when you choose the funds.

For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in