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Should one invest in dynamic bond and liquid funds?

Invest only in high-quality short-duration, liquid and overnight funds, says Dhirendra Kumar

In the current interest-rate scenario, should one invest in all-seasons bond and liquid funds? I invested in an all-season bond fund and earned quite a meaningful return. Further, will it be safe to invest in liquid funds after the Franklin episode?
- Gaurav

As far as liquid funds are concerned, there is less chance of making losses. This is because the way the liquid funds have been designed, as well as its operating framework has been tightened over the years, there is nothing to worry much about liquid funds.

With regard to all-weather and dynamic bond funds, where you were able to generate profitable returns given the falling interest rate scenario, one should not have any high-return expectations, especially in debt funds. When one invests in debt funds, fund managers invest the money in various companies and the expectation is of timely repayment. This is judged by the ratings available. Given the current economic situation, many companies with high-grade ratings wherein mutual funds have entrusted their money may face problems repaying their obligations.

Now one does not know which company will face this problem, to what extent and how much of your money has been invested in such companies. So, there is a possibility that the returns may seem good today but some of your money may get caught, there may be some rating downgrades or companies may not be able to repay the money. Such kinds of issues are now coming up.
More so, such issues started emerging even before the onset of the current crisis.
Since October 2018, following the IL&FS crisis, some investors have been witnessing small punctures in their debt funds in terms of their money being locked in bad bonds.

The possibility of such losses in liquid funds is very less. Still, in expectation of a higher return, do not aggressively invest in debt funds at this time. This is not the right time to have increased return expectations from fixed-income funds. Rather, invest only in high-quality short-duration, liquid, and overnight funds.