Suresh Sadagopan of Ladder7 Financial Advisories discusses the way forward in dealing with debt mutual funds after the currency depreciated and RBi's steps to stem its volatility.
Ladder7 Financial Advisories
You might be aware of the free fall of the rupee in the past couple of months. In the past year it has depreciated by 29 percent. The Reserve Bank of India (RBI) wanted to step in and arrest the free fall. However, the sale of dollars by RBI did not stem the tide of depreciating rupee.
Hence, RBI has increased the interest on Marginal Standing Facility (MSF) from 8.25 percent to 10.25 percent. This is the short-term borrowing facility. This over and above the Repo (rate at which funds are available from RBI) which is at 7.25 percent. RBI has restricted the borrowing under Repo to 1 percent of the bank deposits. Also overnight borrowings for all banks put together, is restricted to Rs.75,000 Crores.
This is expected to curtail the pressure on the rupee as it is no longer attractive to make forward contracts, betting on rupees fall.
Read the following article published in Moneycontrol.com regarding RBI move & Marginal Standing Facility. This article will offer some basic information you may need on this.
The Debt MF Problem
Since the cost of borrowings has gone up, yields have gone up on various instruments. It has gone up most on Government Gilts and least on money market securities. When yield go up, the current securities in one’s portfolio would have to go down in value to give the new higher yield. That is why the NAV goes down, when the interest rate goes up.
This correction has already happened, which reflects the mark to market rates on the underlying securities being held in the portfolio of the schemes. Once this gets factored it should now stabilize.
What do you do?
There is nothing much one can do now. Withdrawing from the debt fund is the worst thing one could do now as you would then be booking the losses. Staying invested and waiting this period out till the interest rate cycle starts moving down again, is the correct thing to do.
The action by RBI was a surprise. This action is inflationary and would impact growth. Government & RBI are aware of that. In the current situation, the economy is reeling and the GDP is going downhill.
Hence, one can expect that this is purely a temporary measure to shore up the rupee and growth for the economy will be pursued. For that, inflation control and interest rate reduction need to happen. Interest rates will start moving down again, in due course. That will ensure that capital appreciation will again be possible in the falling interest rate scenario. The key word now is patience.
Can you invest in debt funds now?
The short answer is Yes. The correction has happened. Now, you can invest at lower NAVs. The key attribute is now patience as one needs to invest and wait for the interest rate cycle to turn. Others can invest in portfolios which are built to hold maturity. Shorter tenure investments are suggested.
However, the more adventurous and those with longer time horizons may want to consider medium to longterm funds, even now. When interest rate cycle turns south, these funds will reap the benefits. For those who want to play it safe and avoid volatility to a great extent, they should look for funds where Gilt exposure in minimum.
Debt funds are great instruments to invest due to the fact that all underlying instruments have a coupon (unlike Equity) and hence would always yield returns to the extent of the coupon, if they are held to maturity. That is the key point.
A scheme may hold the underlying to maturity to get atleast the coupon, which would still be a good return, considering the favourable long-term capital gains treatment, which brings the effective rate of tax to just single digits.
Markets cannot be predicted. Markets have a way of making a mockery of the projections of even the most seasoned pundits. Only long-term trends can be predicted with any chance of getting right. That we thought holds for equity, currency, commodity markets. Now we know debt markets can be as jumpy!
The author is a Principal Financial Planner at Ladder7 Financial Advisories.