Is it a good time to invest in debt funds especially income and gilt funds?
-Sangeeth P
The Reserve Bank of India did not change the interest rates in its recent monetary policy announcement onDecember 16, 2011. It is common for debt funds to find favour with the fall in bond yields and the rise in bond prices, which is what, has probably made you pose your question. There is an inverse relation between bond prices and interest rates and hence whenever interest rates rise; the yields of new bonds rise, but prices of existing bonds fall. Likewise, when interest rates decline, the price of existing bonds increases and bonds are often sold at a premium to the face value.
Bond prices affect debt funds directly since debt funds largely invest in bonds. So, when the bond prices go up, the net asset value of the fund increases. Even last week the RBI governor indicated that rates may head downwards soon. However; with the union budget to be announced two months later, in all probability rates may actually be cut after the budget. In a falling interest rate scenario, debt funds are likely to provide decent returns, particularly the long-term debt funds. Although all types of debt funds gain from lowering of interest rates, the benefit is less pronounced in the case of liquid funds but is the most in case of long-term debt funds, including gilt funds. All these outcomes are not without risks; if inflation does start to rise, it will be reason enough for the RBI to firm up the prevailing yields owing to tighter liquidity in the market. If yields rise, your investments made now may suffer and hence make your investments assessing your risk profile and understanding of these possibilities.
This article was originally published on January 24, 2012.
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