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Debt Fund Volatility

Debt funds too can give negative returns

I have invested in ICICI Income Plan on August 20, 2009. Despite this being a pure debt fund, the net asset value (NAV) has been going down. Are debt funds not supposed to be safe? Can they give negative returns as well?

- Mehul Somaiya

Contrary to general perception, the principal and returns in debt funds are not assured and can give negative returns. But certainly, they are not as volatile as equity funds. The market prices of debt instruments are inversely related to the interest rates. Whenever the interest rates rise, the value of debt instruments will go down. As a consequence, the debt funds lose. This volatility is observed more in medium- and long-term debt funds than short-term debt funds and liquid funds.

Due to the ongoing government borrowings, the interest rates went up during August. The fresh bond issue caused the prices of bonds to fall, and hence the medium-term debt funds lost. We further expect the medium- and long-term debt funds to be volatile in the coming months. The average return of this category for the month was -0.44 per cent while the fund had lost 0.45 per cent.

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