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Retail investors may safely invest in shorter-duration funds, suggests Sanjay Kumar Singh.
The one-year returns of different categories of debt funds are broadly in line with their average duration -- longer-duration funds and gilt funds have performed the best, followed by medium-to-long-duration funds, with shorter-duration funds bringing up the rear.
However, investors must avoid choosing debt funds based on past returns, and instead select them based on a forward-looking assessment.
Short-term yields may harden
Between March and December, the Reserve Bank of India took several steps to support the economy, like reducing interest rates and providing liquidity support.
"As the economy improves -- and data seems to point to that -- the need for such extraordinary support will end and these measures will get reversed," says R Sivakumar, head -- fixed income, Axis Mutual Fund.
Adds Vikas Garg, head-fixed income, Invesco Mutual Fund: "RBI has recently sucked out about Rs 2 trillion of liquidity through a 14-day variable reverse repo."
As liquidity tightens, yields on shorter-term assets are likely to rise.
Longer-term interest rates need watching.
"Domestic inflation needs to be monitored closely, especially against the backdrop of the recent jump in commodity prices," says Garg.
Rate hikes are not on the anvil yet.
"RBI is likely to continue its accommodative policy stance over the medium term to support the nascent recovery," says Garg.
According to him, RBI's continued purchase of dated G-Secs via Open Market Operations and renewed demand from foreign institutional investors due to high global liquidity could support long-end rates, which are at elevated levels.
Should you invest in credit funds?
Investors have been wary of credit risk funds for some time.
Some fund managers believe it is time to look at them again.
"The spread between 'AAA' and non-'AAA' bonds has been very high. As the macro-economy improves, credit-oriented funds will do well," says Sivakumar.
According to him, developments over the past six months indicate that fears were overblown.
Steps taken by the government and RBI -- like partial credit guarantees, targeted long-term repo operations, etc -- took care of companies' liquidity-related worries.
"Fears of widespread credit issues have not been borne out so far. Even the data on corporate profit performance and the number of companies that have taken the moratorium indicates things may pan better than expected," says Sivakumar.
Other fund managers remain cautious.
"While the economy is recovering, GDP is expected to contract by 7-7.5 per cent in 2020-21. RBI's measures averted systemic default risks, but most of the benefits are limited to the top-rated companies," says Garg.
What should you do?
Retail investors may safely invest in shorter-duration funds.
"Invest in categories like ultra-short-duration, low-duration, and money market funds where there are opportunities for reinvestment as yields begin to rise," says Sivakumar.
Risks exist in longer-duration funds.
"Returns could turn negative if interest rates rise," says Ankur Maheshwari, chief executive officer, Equirus Wealth Management.
Risks similarly exist in credit-risk funds.
Of the two, any reversal in a duration fund can be made up for by extending one's investment horizon.
Losses due to credit events tend to be irreversible.
Invest 80-90 per cent of your corpus in shorter-duration funds.
With the rest, take some exposure to longer-duration funds, but match your investment horizon with the fund's average duration.
Only investors with a high risk appetite should venture into credit risk funds.
Feature Presentation: Aslam Hunani/Rediff.com
