Turmoil in debt funds: Are SIPs advisable in bond schemes?

The regulator SEBI also needs to note that the fund category definition, product labeling and AMC communication still weren’t successful in highlighting the real risks (which are not perceived).

The result of all this is that investors are asking questions about debt funds and their relevance.

Take for example the SIP. It’s a way of investing in various assets. In fact, over the last few years, it had become the most popular method of investing in equity funds. Many investors use SIPs to invest in debt funds as well.

Understanding systematic investments

If you understand the concept of SIP well, then you will agree that for it to give good results, the value of the asset/investment needs to show some volatility. Theoretically, in an ever-rising market, SIP is not the best strategy because you are better off investing at one go at the start itself. On the other hand, in a falling market, it is better to delay the investments to get lower prices.

Volatility is there in equity funds. But debt funds aren’t as volatile as equity funds. Debt fund NAVs tend to move up steadily, particularly of those with comparatively shorter durations (longer duration funds can be more volatile). And since NAVs of debt funds don’t fluctuate much, there aren’t enough opportunities to buy at lower prices. Hence the issue of averaging out generally doesn’t arise. So, at least mathematically, lump-sum investments make more sense than SIPs in debt funds. That is, of course, assuming that you have a lump-sum to invest. But most common investors don’t have a large lump-sum to invest. Hence, the need for SIPs in debt funds too.

Now let’s say you are an investor who has SIP in debt funds. You do your math and calculate the right SIP amount for your chosen financial goal. And the suitable asset allocation is 50:50 for the SIP. That is, 50 per cent is invested in equity funds while the remaining 50 per cent is parked in debt funds.

Focus on less-risky funds

As an investor in debt funds, and given the credit events and risks that became evident in the last couple of years, should you still continue your debt fund SIPs?

The answer depends on which debt fund you are investing in. Remember that the SIP is just a way of investing. Whether you should continue to invest in a fund or not depends on whether it is suitable for you and your goal. So, first comes the question of ‘which debt fund’ and then comes the question of SIP or lump-sum. And the latter is also a function of availability of cash flows.

In debt funds, it’s more about the preservation of capital and less about return maximization. If you go for the latter, you will end up taking risks which are not justified because the additional returns will be just a couple of percentage points, that too only in good years. At other times, the risk can and will backfire. So it’s not worth it.

If you are an ultra-conservative investor, then don’t do debt fund SIPs. Debt funds aren’t risk-free. And given your risk-averse nature, better to stick to bank deposits for short-term goals and small savings schemes such as EPF, PPF, etc. for long-term goals.

But if you are a moderately aggressive or even a balanced investor, you are better off not taking any credit risk at all. You can’t eliminate this risk in debt funds, but you can minimize it for the time being by sticking only to good overnight, liquid and ultra-short duration funds. Even within these categories, pick funds that do not have hidden risks embedded in their portfolios. Avoid adventurous fund managers who chase small incremental returns (to beat peers) by taking unnecessarily high credit risks.

For that you need to look into individual fund portfolios. Debt funds aren’t easy to analyze due to their inherent structures. So you need to carefully approach debt fund selection for your portfolio. If this is not something you are capable of or willing to do, then take professional advice. No point taking blind shots in debt funds.

Recent events and misadventures of a few have given a bad name to the entire category of debt funds. But we cannot paint every debt fund with the same brush. It is still reasonable to believe that over a sufficiently long period, SIP in safe and prudently managed debt funds will give decent returns with sufficient tax efficiency.

(The writer is the founder of StableInvestor.com)