Dear Friends,
Let me take this opportunity to wish you all Merry Christmas and a very Happy new year. I hope you all had a very good 2022 especially after almost 2 years of disturbed conditions with on and off @ lockdowns due to covid. Hope you all roamed and socialised a lot.
Stock markets across the globe had challenging times this calendar year except for our own country and few Asian peers. However for India the action was more in small and midcaps than in Indices since we are as on today lower than the Oct 2021 high on nifty @ 18600. So most of the large cap and index funds have not given good returns vs may be a good corporate FD and my fear is that next 3/6 months will be more challenging.
If we see last year we had significant rate hikes by developed economies like US, UK, Europe and also Japan. These rate hikes were not only very big but also very fast. Ideally India would have tanked in such situation but for
- Good forex Reserves
- DII support on lower Index levels
- Our own strong revenue collections and Govt spending
- China +1 and Europe+1 ( thanks to the Russia – Ukraine war and consequent spike in energy prices in Europe)
While the 4th point is very volatile and we don’t know what will happen when China comes out of covid completely and Europe resumes production, if war stops. However 1st 3 points looks very stable in longer term. In near term we have fixed incomes rising their head very fast and people have started taking interest in deploying money there. This can be potential danger to the flows to equity MF and may be SIP numbers can also reduce in near future. Also rising interest rates is not very good for industries as it reduces leveraged companies profits and consequently government revenue collection. So trying to figure out where we are in the interest rate cycle becomes very important.
While nobody has answer to this question but we are attempting to make a logical guesstimate here.
History of rate hikes since March 2020 in India
While US Fed reserve has been very aggressive by already raising rates by almost 400 basis points this year and still not done with. Expectation are that they may increase the rate by 60 to 75 basis points more next year and mostly bring it back to 4.25% only by end of 2024. While inflation has started cooling off in US and it will definitely cool down from Feb 2023 taking the base effect ( since last year crude oil and consequent inflation started spiking once the war started in feb 2022). However Fed does not want to quick fix this time and they are targeting the reasons behind the inflation and one of them being labour market which is still red hot. Our assessment is FED will see the impact on labour market also very very soon once the festive season is gone and pmi (Purchasing Managers Index) will come down sharply. Service Industry has already started cooling off with layoffs announced by most of the IT companies including the 4 big boys (Amazon, Google, Facebook and Netflix). While we may be in the last phase of interest rate hike and markets were cheering it few weeks back what spooked the US markets and rightly so is the fact that these high rates will prevail for mostly entire 2023. If this happens India will not be spared and we will have to shell out some part of our outperformance. India has raised rates only by 225 basis points (The reason being we have handled inflation far better than US) however the Banking system has just started giving benefit of this rate hike to deposit holders to raise their war chest of deposits. Our assessment is we may also have to raise rates by 50/75 basis points and mostly this will happen in next 3/5 mts itself. What stands for India is neither the Government nor the companies are heavily leveraged since the capex announced are mainly from Government and some few big corporates. Our understanding of last quarter’s results show that most loans borrowed were working capital or short term loans and they can be shed easily when business slows and hence banks will not have the repeat of NPA cycle very soon. Of course Independent Fin techs and may be NBFCs may feel pain as interest rates get dearer and intenses competition in lending continues.
In such a scenario since valuation in our markets are already elevated and especially our outperformance is also at record high levels, one should mellow down the hopes on high returns from equity. As an investor in equity and MF we should consider opportunity to increase exposure on some correction rather than thinking of doing any lump sum investments or increasing exposure to equities. Atleast we are readying ourselves for some negative surprise in the near future. One very positive thing for our economy is the fall in crude oil prices and if it sustains at levels of 75/80 our upside might increase.
Conclusion: near term cautious mostly 3/6 months and bullish on longer term
Advice: keep some powder dry to deploy at lower levels.
KNOWLEDGE CENTER
What are Debt Funds?
A debt fund is a mutual fund scheme that invests in debt instruments like Corporate and Government Bonds, corporate debt securities, and money market instruments, etc. There are different types of debt funds to suit investors with varying risk-return profiles, investment horizons, and financial goals. Debt funds invest in all kinds of debt, such as treasury-bills, government securities, commercial paper, and certificates of deposits, money market instruments, securitized debt, and corporate bonds. It is also known as Fixed Income Funds or Bond Funds.
The key difference between a debt fund and an equity fund is that they invest in different asset classes. Equity funds invest 65% or more of their assets into equity and equity-linked products, while debt funds hold mainly bonds and cash assets. Remember that the value of an investment depends on the prices of the securities that make up the investment. Since bond prices tend to be less volatile than stock prices, debt fund values are more stable than the value of equity funds. In other words, debt funds are considered to be less risky, especially when held for short periods of time.
Types of Debt Funds - Here are the different types of debt funds:
- Overnight Funds:
Overnight Funds invest in securities having a maturity of 1 day, typically money market instruments. These funds aim to provide liquidity and convenience, rather than high returns. They are suitable for investors (mainly corporate treasuries) looking to park funds for a very short period.
- Liquid Funds:
Liquid Funds invest in debt securities with less than 91 days to maturity. They are suitable for investors who want to park temporary cash surpluses for a few days, as they provide steady returns with minimum NAV volatility.
- Ultra-short Duration Funds:
Ultra-short Duration Funds are suitable for investors who have an investment horizon of at least 3 months. These funds earn slightly higher yields than liquid funds and are considered to be a low risk investment. Some ultra-short duration funds may invest in lower-rated bonds to push up their yields.
- Low Duration Funds:
Low Duration Funds are moderately risky and provide reasonable returns. They are useful for those looking to invest for around 6 months to one year. Their portfolio may include bonds with a weaker credit rating to kick up yields.
- Money Market Funds:
Money Market Funds invest in debt instruments with maturity up to one year. They aim to generate returns from interest income, while their slightly longer duration offers some scope for capital gains.
Short Duration Funds invest in a judicious combination of short and long-term debt, as well as across credit ratings. These funds are recommended for investment horizons of 1-3 years. They usually earn higher returns than liquid and ultra-short duration funds, but also show more NAV fluctuations.
- Medium, Medium to Long and Long Duration Funds:
Under normal situations, the portfolio duration of a medium duration fund has to be between 3-4 years, medium-to-long duration fund between 4-7 years, and long duration funds greater than 7 years. These funds invest in short and long-term debt securities of the Government, public sector and private sector companies. They tend to do well when interest rates are falling but underperform when rates are rising. Thus, they carry fairly high interest rate risk.
- Fixed Maturity Plans (FMPs):
Fixed Maturity Plans (FMPs) are closed-end funds that invest in debt securities with maturities that match the term of the scheme. FMPs typically invest in low-risk, highly-rated debt and hold passively until maturity, when the securities are redeemed and paid out to investors. The main advantage is that the FMP structure eliminates interest rate risk and enables investors to lock in interest rates. The main drawback is that though FMPs are listed, liquidity tends to be low.
- Corporate Bond Funds:
Corporate Bond Funds must invest at least 80% of the portfolio in AA+ or higher rated corporate bonds. Such funds are appropriate for risk-averse investors looking for regular income and safety of principal.
- Credit Risk Funds:
Credit Risk Funds invest a minimum of 65% of total assets in corporate bonds rated AA or below. That is why they usually generate higher yields as compared to the more conservative corporate bond funds. Investors who are willing to take on higher default risk may consider investing in credit risk funds.
- Banking and PSU Funds:
Banking and PSU Funds invest at least 80% of total asset in debt instruments issued by banks, PSUs, and public financial institutions. This is a moderate risk product that seeks to balance yield, safety and liquidity.
- Gilt Funds:
Gilt Funds invest in government securities of varying maturities. They can be short or long duration funds, depending on the maturity of their portfolio. Gilt funds have zero default risk, because they invest in safe G-sec.
- Gilt Funds with 10-year constant duration:
Gilt Funds with 10-year constant duration invest at least 80% of total assets in G-sec and maintain a constant portfolio duration of 10 years.
- Floater Funds:
Floater Funds invest at least 65% of their assets in floating rate bonds. These funds carry less MTM risk because the coupons on their floating rate debt holdings are reset periodically based on market rates.
- Dynamic Funds:
Dynamic Funds have no restrictions on security type or maturity profiles for investment. The best performing dynamic funds manage their portfolios dynamically and flexibly according to market situations.
Why invest in debt funds?
Debt funds offer many benefits, especially to retail investors, or to investors who have traditionally kept their money in bank deposits.
- Access to Professional Expertise and Market Returns:
Investing in a debt fund offers the opportunity to earn interest as well capital gains from debt. It allows retail investors to access money markets or wholesale debt markets- segments in which they cannot directly invest.
- Lowers Portfolio Risk:
Since debt funds are less risky than equity funds, a strategic allocation to the best performing debt funds reduces risk and brings stability to an investment portfolio. Tactical investments in debt funds are useful to take advantage of temporary yield opportunities.
- Range of investment options:
Debt funds are available along the entire spectrum of maturity and credit risk. Shorter duration funds generate regular and stable income. Longer duration funds earn from interest income as well as capital gains, and suit investors who can take on higher NAV volatility. Overnight funds, liquid funds, corporate bond funds and low duration funds tend to invest in the safest debt products. Ultra-short and short duration funds may be structured to take on credit risk to provide higher returns.
- Liquidity:
Debt funds are very liquid, and can be redeemed easily, usually within one or two working days of placing the redemption request. Unlike bank fixed deposits or recurring deposits, there is no lock-in period. While a few funds may impose a small exit load for early withdrawal, in general, there are no penalties when a mutual fund investment is withdrawn.
- Low Cost Investment:
According the SEBI norms, the total expense ratio of a debt fund cannot exceed 2% of Assets under Management. Among debt funds, overnight and liquid funds have very low expense ratios, while dynamic and long-term funds charge higher expense ratios.
MUTUAL FUND SIP RETURNS
CATEGORY AVERAGE RETURNS
-CA JAYESH GANDHI
Disclaimer: This is an informative document and opinions expressed in it are our own and not any advice. We are AMFI registered MUTUAL FUNDS DISTRIBUTOR.
