Don't do systematic investment in short-term debt funds

Investors seem to be rushing to short-term debt funds or liquid funds with tenures less than a year.

With the Union Budget making debt fund taxation unattractive -- for tenures between one and three years -- investors feel they are better off betting on these short-term schemes, say fund managers.

Some are taking the systematic investment plan route, recommended for long-term funds or equities.

“Investments in debt funds, especially liquid funds are happening by way of SIPs.

This might also be because there is no exit load and lock-in for these funds,” says Anutosh Bose, chief operating officer, LIC Nomura Mutual Fund.

As in the case of equities, SIP is a way to discipline investment habits.

It is largely advised for equity investments, owing to higher volatility in the asset class.

As this makes cost averaging more prominent in equities than in other asset classes, SIPs are more associated with equities.

“Bond yields can also be volatile, as these are linked to the money market.

"Investors put money when bond yields are rising.

"Sometimes, when bond yields are at 8.5-9 per cent levels, as is the case now, investors hold back investment, thinking it might rise further,” says Murthy Nagarajan, head (fixed income), Quantum Mutual Fund.

R Sivakumar, head (fixed income), Axis Mutual Fund, says systematic investment in any asset class works better if invested through a whole cycle.

“If one had invested in debt funds (through SIP) four to five years ago, he/she would have seen better results.”

Interest rate cycles usually stretch through four-five years.

According to data from mutual fund rating agency Value Research, through the past five years, liquid funds returned 7.5 per cent annually, income funds seven per cent, and short-term and ultra short-term

funds returned eight per cent.

For the past three years, income funds returned 8.45 per cent, liquid funds close to nine per cent and short-term and ultra short-term funds nine per cent.

For the past year, income funds returned close to nine per cent, liquid funds over nine per cent, short-term funds around 10.5 per cent and ultra short-term funds close to 10 per cent.

Nagarajan says now is the right time to invest in debt funds through SIPs, as rates have been stagnant for sometime and rate cuts aren’t likely immediately.

Also, the idea behind investment through SIP is taking out the time call.

An SIP of Rs 5,000 in liquid funds (nine per cent) through the next five years will give Rs 377,000.

However, interest rates are likely to start falling in the medium term.

Nagarajan says SIP in debt is recommended in a rising interest rate environment.

Sivakumar says ideally, SIPs, when done in longer-tenured debt funds, show better results.

“Shorter-tenured funds such as money market and liquid funds are less volatile compared to longer-tenured debt funds such as income funds.

"Consequently, the benefit of cost averaging through SIP will be less in shorter-tenured funds.”

SIP in debt funds is recommended as introductory products for risk-averse investors.

Investors can use the SIP route to accumulate and, subsequently, shift the amount periodically to other asset classes, says Bose.

Those with regular income, too, could opt for SIP in debt funds.

Savvy investors could invest a lump sum, if bond yields are high.

And, they should follow this investment with SIP later, possibly when rates fall, says Sivakumar.