VR Logo

When do debt funds do well?

A falling interest rate outlook is beneficial to debt funds, says Dhirendra Kumar

I assume that debt funds are good in a deflationary environment. If I am correct, then what type of debt funds would do well during times of deflation?
- Parthiban Parthi

No, I think that nothing is good during deflation. I would say that debt funds tend to benefit if we have an interest rate outlook whereby it looks imminent or reasonable to think that the only way interest rates will go is downwards. Particularly, debt funds that invest in securities with longer maturity-like long-duration funds or gilt funds-tend to benefit the most when interest rates go down and that is what you would have seen so far.
Over the last six months or so, we have seen successive rate cuts and its impact on gilt funds, which have been giving good returns while everything else has been struggling. This category is also ultra-safe in a sense that this category's underlying securities, which are gilt securities, have negligible default risk. Besides, we don't have very long-term corporate bonds, but we have long-term gilts available. So, these funds benefited a lot and they can benefit further if we have more interest rate cuts. But at the same time, you must be prepared to exit such funds as interest rates are cyclical. When interest rates go up, then these funds fall dramatically and lose money. The onus here is on you that if you are entering and benefiting from investing in such funds, then you have to be prepared to take your money out before the interest rates start going up again.