Rising interest rates & debt fund investments

Rising interest rates & debt fund investments

Subject: Economy

Section: Monetary Policy

Concept :

Investors who put money in debt mutual funds and other securities are worried about their returns as the Reserve Bank of India prepares to raise interest rates in the coming months to tackle inflation.

Impact debt funds?

• A rise in rates of interest-the value of debt funds and other instruments falls as an investor feels he/she can get a new debt fund with a higher interest/coupon rate and thus, won’t go for existing funds at lower interest rate or coupon rate.

Technically, debt investors will lose out when interest rates go up,as the net asset value (NAV) of debt funds decline. NAV is the total value of the debt portfolio divided by the total number of units on a particular date.When Interest rates rise,the yield or coupon rises but the value declines, bringing down the NAV.

• A fall in interest rate interest rates -the value of the bond or debt mutual fund rises. The reason is that the interest rate on old bonds remains high when compared to the new bonds or funds that are floated.

Alternatives:

• Diversified portfolio-a combination of liquid to money market funds and short-term debt funds, and/ or dynamic bond funds with low credit risks should remain the core fixed income allocation strategy.

Investment in the long term debt mutual funds- longer holding period avoiding the current turbulence.