Investors can continue with long term debt mutual funds

Arnav Pandya

Investors are now getting worried about the risk that the various bond funds and other income funds have following the J P Morgan case and this is reflected in the data wherein in a single month they have pulled out more than Rs 26,000 crore from such funds in September. The question for other investors who might not have done much till now is whether they should follow the herd and ensure that safety has the first priority or should they adopt a contrarian approach and see how the situation turns out. This requires a careful consideration and hence is something that needs the attention of every debt fund investor. Here are some additional details in this area.

Different types of funds

Investors should first take a look at the fund where they have put their money and the nature of the fund. On an overall level this might be a debt oriented fund but within this there could be a lot of differences in terms of the construction of the portfolio. Thus one can have a bond fund or a credit opportunities fund where the primary investment is in corporate bond and in the latter case in companies where there is a slightly higher risk as these offer a slightly higher rate of return. On the other hand a long term income fund would have some bonds and debentures and at the same time also government securities in its portfolio. Looking at these funds they are different in terms of the risk that they hold and this is the key point on which one should be able to distinguish the various investments.

Interest rate fall

The overall economic situation remains one where there is likely to be a continuation of the fall in the interest rates though at a slower pace and this is a clear indication of the trend. The interest rate movement is going to be on the downside and the investor should be able to make use of the conditions to ensure that their debt portfolio is earning a higher rate of return. This means that they should use income funds to the extent possible as this will be one of the best ways to able to play out the situation. A fall in the interest rates leads to a rise in the bond prices. This benefits the mutual funds and other investors who hold the bonds as the value of these rises. This in turn pushes up the net asset value of the fund and investors witness a higher rate of return as the rise in the NAV will consist of the interest payments as well as the capital gains that have been earned on the investments.

Reducing risk

The investor at the same time must ensure that they are paying attention to the risk element and while they should make use of the falling interest rate they would need to take a relook at the options that they would choose. On this front riskier bond funds or those funds that have a lower rated paper in their portfolio can be avoided. This might promise higher returns but with a wave of downgrades being witnessed there is also a higher risk element that is present in these funds. Conservative investors who do not want to take a higher element of risk at this stage could simply stay away from these funds but move towards others that have an exposure to long term debt but this includes just high rated paper along with government securities. This effort if successful can ensure both peace of mind as well as exposure to the right asset in order to gain from the overall situation.