Investing in debt funds is an essential strategy for those looking to diversify their portfolios and secure stable returns. With the evolving economic landscape and recent changes in government borrowing, 2024 presents unique opportunities for savvy investors. This article explores how to maximise returns with debt funds, considering the latest market trends and expert insights.
Understanding Debt Funds
Debt funds are mutual funds that invest in fixed-income securities like bonds, government securities, corporate debt, and money market instruments. These funds aim to provide regular income and capital preservation, making them a popular choice among conservative investors. The returns from
debt funds are influenced by interest rate movements, credit quality of the securities, and the duration of the investments.
Recent Developments in Government Borrowing
In the interim budget for 2024, the Indian government announced a reduction in its borrowing for the fiscal year 2024-25. The gross and net market borrowings through dated securities are estimated at Rs. 14.13 lakh crore and Rs. 11.75 lakh crore, respectively, which is lower than the previous fiscal year. This reduction in borrowing has significant implications for the debt market.
Impact on Bond Yields
The government's borrowing levels influence bond yields. Typically, a higher supply of bonds leads to higher yields and lower bond prices. Conversely, a lower supply results in lower yields and higher bond prices. With the government's reduced borrowing, bond yields are expected to remain subdued, making the market more favourable for private issuers to borrow at lower costs.
Benefits for Private Institutions
Lower government borrowing means that private institutions can issue bonds at lower yields, reducing their overall borrowing costs. In a falling interest rate environment, the prices of existing bonds in the secondary market tend to rise. Since government securities are considered risk-free, private institutions must offer higher interest rates to attract investors, compensating for the higher risk compared to government bonds.
Positive Impact on Debt Mutual Fund Returns
The reduced supply of government bonds will positively impact the returns of debt mutual funds. There is an inverse relationship between bond prices and yields; as yields fall, bond prices rise. Investors holding debt mutual funds will likely see higher returns due to the appreciating bond prices in the secondary market.
The government's decision to reduce gross borrowings by 8% will push down benchmark bond yields, boosting the returns for debt mutual fund investors over the next few months.
Lower supply and growing demand for bonds will lead to price gains in existing bonds, enhancing returns for fixed-income assets subject to mark-to-market valuations.
Inclusion of Indian Government Bonds in Global Indices
Another critical development is the inclusion of Indian government bonds in two global indices: JP Morgan Government Bond Index-Emerging Markets (GBI-EM) from June 2024 and Bloomberg Emerging Market Local Currency Government Indices from January 2025. This inclusion will drive international flows into Indian bonds, increasing demand and further lowering yields.
The inclusion in global indices will boost demand for Indian government bonds, reducing yields and creating opportunities for long-term investors in G-sec mutual funds.
Which Debt Mutual Fund Categories Will Benefit Most?
According to SEBI categorisation, there are 16 types of debt mutual funds, including dynamic bond funds, corporate bond funds, and gilt funds. When bond yields fall, long-term bond funds benefit the most due to their extended maturity profiles.
Funds with higher durations, such as long-term debt funds and dynamic debt funds, will benefit the most from reducing interest rates. Long-duration G-sec funds will also gain from decreasing yields.
Duration category funds like gilts, bonds, and dynamic bond funds have been key beneficiaries. Short- to medium-term funds also benefit but to a lesser extent.
Example: Impact of Bond Maturity on Prices
Consider two existing bonds with similar risk profiles and an interest rate of 6%. Bond A, with a maturity of seven years, is trading at Rs. 110, while Bond B, maturing in two years, is trading at Rs. 103. If the interest rate for new bonds drops to 4.5%, the prices of these bonds will rise in the secondary market. However, Bond A will see a more significant price increase due to its longer maturity.
Advantages for Existing Debt Mutual Fund Investors
Existing investors in debt mutual funds are well-positioned to benefit from rising bond prices due to falling yields. As bond yields drop, the prices of bonds held by these funds will increase, leading to higher returns.
Existing investors will see capital gains as bond prices rise. However, new investors might not benefit as much since the yield movement has already started.
Current investors will benefit more. While new investors may still gain, the returns will be lower compared to those who invested earlier. The RBI's steady interest rate policy since April 2023 suggests a cooling-off period before new investors see higher returns.
Expected Returns and Investment Strategies
Good returns are subjective and depend on various factors impacting yields. In an easing rate cycle, fixed-income products will offer superior risk-adjusted returns over the next 12-18 months.
Debt mutual fund investors should hold their investments until interest rates bottom out, which could take 1-2 years or more.
Conclusion: Strategic Investments in Debt Funds
The reduction in government borrowing, coupled with the inclusion of Indian bonds in global indices, presents a promising outlook for debt mutual funds. Lower bond yields and higher bond prices will benefit existing debt fund investors, while new investors might see moderate gains.
Investors should consider long-term and dynamic debt funds with higher durations to maximise returns. Monitoring interest rate trends and market conditions will be crucial for making informed investment decisions. By understanding these dynamics, investors can effectively leverage debt funds to enhance their portfolios and achieve their financial goals.
In summary, 2024 offers a favourable environment for debt fund investments, driven by strategic government actions and global market integration. Staying informed and strategic will enable investors to capitalise on these opportunities and secure stable, attractive returns from their debt
mutual fund investment.
