What should be the strategy for the coming one year so far as debt funds or dynamic bond funds are concerned? Can they be replaced with MIPs if one is looking for capital preservation too?
Gone are the days when debt funds were regarded as one of the safest investment avenues. Capital preservation is out of question for now. Yes, one can minimize the probability of capital loss but that needs some investment planning and dynamic approach towards debt funds investing. Volatility has now become an inseparable feature of the Indian debt market and is likely to increase with time. Debt fund investing won't be that easy in the coming years as it has been in the past and one has to reduce the return expectations from them in years to come.
Since the investment universe of both income funds and dynamic bond funds are almost similar, they are bound to be volatile. However, dynamic bond funds are expected to be relatively less volatile vis-à-vis income funds but that too depends on the fund manager's view on the market. If fund manager expects the interest rates to go up, he will reduce exposure in long tenure bonds in favour of short-term bonds. Here, the fund manager also has the option of investing a large portion in cash (35-100 per cent of net assets). This flexibility may protect the fund during bad times, but the fund may lose out in the subsequent recovery phase.
Hence, the best strategy for debt fund investing for now would be to spread your investment over different categories of funds. Apart from a combination of above two types of funds, floating rate funds can also be considered. Floating rate funds have a good track record of consistent performance even during worst periods. But, first and foremost thing to look at is for how long are you willing to stay invested in a fund. Consider above funds only if your investment horizon is over a year or so. Otherwise, short-term or cash funds would do. If liquidity is not a constraint then one can also consider a small combination of guaranteed fixed-income instruments like bank fixed deposite, RBI Savings Bonds, NSC, etc.
Coming to MIPs, think of them only if you can stay invested for over a year or two. Even though MIPs work as an asset diversification tool, their marginal equity exposure makes them more volatile than debt funds. Thus, replacing debt funds with MIPs won't be advisable under the current market scenario. Yes, a small allocation to MIPs can be considered in addition to the existing debt fund investments depending on your risk taking ability.
Whatever you do, just remember that within the mutual funds' universe, capital preservation is only confined to cash funds. But investment in them is only advised for parking short-term surpluses. To get higher return, one will have to take higher risk now. But a high risk may not entail higher return. Thus, diversification within same asset type as well as over different asset classes is the flavour of the season. Therefore, maintaining a fine balance between risk and return expectations should guide your investment decisions.