Debt fund NAVs are falling. What should investors do?

ETMutualFunds.com asks mutual fund advisors and financial planners every week for a list of frequently asked queries by their clients. Often, these questions would be very topical, something that may be worrying many regular investors. The idea is to present the questions and the response of these advisors/planners to those questions for the benefit of our readers. This week we spoke to Harshad Chetanwala, Co-founder of MyWealthGrowth, a financial planning firm in Mumbai, to find out the common queries of his clients. Often, these questions would be very topical, something that may be worrying many regular investors. The idea is to present the questions and the response of these advisors/planners to those questions for the benefit of our readers. Read on.

Financial Planner: Harshad Chetanwala is the Co-founder of MyWealthGrowth, a financial planning firm in Mumbai.

Questions asked by investors:

Why are the NAVs of our debt funds falling?

Can this lead to a Franklin-type shut down in schemes?

Which debt schemes are free of these risks?

His response to his clients:

The recent increase in the 10-year benchmark bond yield has impacted the NAVs of debt funds. The yield and price of the bonds are inversely related. When the yield goes up, the prices of bonds fall. Since the yields went up recently, the prices of the bonds currently held by the debt funds came down and this resulted in the fall in the NAV of the funds.

The simple thumb rule for investing in debt is: when the interest rates are around or below 6%, it is better to invest in debt funds like liquid funds or ultra-short duration funds or low duration funds. Or it could be even short-term fixed deposits with banks. When the interest rates are around or above 8%, the time is good to invest in long duration debt funds.

Some investors are naturally worried after noticing negative return on debt funds in last week because the first thing to strike their mind is the experience of Franklin Templeton investors where the fund house closed 6 debt funds.

That decision of the fund house was more to do with the credit risk where the companies to whom the money was lent were unable to fulfill the repayment terms agreed at the time of investment, and they are putting efforts to recover it from those companies. Investors should understand these risks are associated with their debt funds.

Another kind of risk is the default risk where the borrowing companies are not at all in position to repay and it must be written off.

The negative returns in debt funds right now are not due to credit or default risk. It is due to what is known as interest rate risk due to the fluctuation in the interest rate. The interest rate risk always exists in debt investment. Longer the duration or maturity of the debt instrument, the higher the risk.

The allocation plan in debt for investors depends on their needs and life stage. For investors relying on debt funds for their regular needs should have most of the allocation in funds with average maturity of 1 – 3 years along with 10-15% allocation in liquid or ultra-short duration funds.