The flooding of liquidity in the banking system following the demonetisation move has led to an impact in the debt markets also. The high amount of liquidity means that there is enough liquidity available for use in the system and this is pushing the yields lower. Banks on their parts are reducing their interest rates and this means that the rate of return from debt instruments is going to fall further in the days to come. Investors who have invested in debt funds would find that the returns that they are seeing has jumped as the yields have gone down but this also raises the question of how they should deal with the instruments in the future. Here is a detailed look at the issue.
High returns
Since there has been a fall in the interest rates and yields the existing debt fund investors would find that the situation looks good. The fall in yields leads to a rise in the bond prices and consequently the net asset value of the bond fund rises. Due to this reason the rate of return for existing investors has gone up. At this moment if one looks at the rate of return on debt funds over a one year period ending in the middle of December 2016 then the long term funds are witnessing an average return that is in double digits. This is good news but it also comes with an element of caution which is that new investors looking at the existing performance should not expect a similar situation going ahead.
Composition
There are two parts to the return that is generated by debt funds. The first part is the coupon payment that is earned by the mutual fund on the debt instruments that are held in its portfolio. At the same time there is also trading of the instruments in the secondary market so there can also be capital gains or losses on the investment and this is the second component to the return. Currently the capital gains part due to the rise in the bond prices has contributed to the higher return that is being witnessed. Going ahead this might not be present and at the same time the coupon rates on new instruments could also reduce and this would go on to keep the returns from the instruments in check. This is something that has to be known and hence the investor should be prepared to face the situation and not go in with wrong expectations.
Strategy
The need for using debt oriented mutual funds still remains and hence the investor should be looking at how he can make use of the opportunities that are present around. The returns that are earned have to be seen in the context of the overall situation and hence if they drop from the ones seen in the past this still needs to be compared with the other instruments and what they yield at the current point of time. This will show that while returns from fixed deposits and other instruments are falling the debt mutual funds will end being slightly better on this front. Investors for their very short term needs should look at liquid funds and short term funds while long term needs would be met through the use of income funds. These are important as the time period of the investment has to match with the appropriate fund so that the risk element in the investment is kept under control. This is another aspect which will ensure that the investor does not have to worry much when things are tough and hence is a way to safeguard their interest.