Written by Awdhesh Nagar
In last 2-year medium to long term debt funds have given great returns. Most of Medium to long term debt have given 10%+ kind of return.
Debt funds are sensitive to interest rate movements. They have inverse relation to interest rates in economy. If interest rates come down debt will give better return and vice versa. Why so?
I will explain with an example. Assume you buy a 5-year bond giving 8% return on face value of 1 lac. So, you will earn Rs 8000/- for next 5 years from this bond. After a year interest rates have dropped and new bonds issued by same entity is at 7%.
Your bond of 8% will earn 1% higher for next 4 year than current bond so if someone has to buy your bond, he will pay a premium to compensate for 1 % extra earning for naext 4 years. This will increase bond price and same bond will sell for around 1.03-1.04 lacs. In this case bond has given 8% interest + premium of 3-4% around 11-12% return. Longer the period of bond higher the price increase. That is the reason of great return of debt fund in last 2 year.
But in case of rising interest rates scenario bond price will fall as their return will be lower than return on new instruments and you may see loss in market price of bond. There can be other reasons also effecting prices of debt instruments like demand supply, govt deficit, credit rating etc.
We have recently seen defaults in few credit opportunities funds. Hence it is advisable to take help of an advisor who understands risk and return associated with debt investment. Don’t fall prey to past return generated by fund. We can make very good use of debt fund investment and generate good return with liquidity and tax friendly options if we invest judiciously.
Awdhesh Nagar is an experienced banking and finance professional. He did his B.Com (H) from Sri Ram College of Commerce and MBA-Finance from University of Delhi. He currently runs his own organisation by the name ‘Moneylogist’ which advises more than 300 clients on their personal financial planning. He is on mission to improve financial literacy and responsible for financial well-being of his clients. He regularly visits education institutes as guest speaker and provides his views on budget and economic events on media.
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https://www.moneylogist.com
