Widely read:
What is the relationship between debt funds and interest rates? How does it work?
It's a very funny relationship. Most investors are quite intrigued by this: when interest rates go up, bond prices go down simply because when interest rates go up, all the older bonds will keep yielding the lower interest rate on which they were issued. So, they fall in value. And this is something which most naive mutual fund investors don't understand: the interest rate went up, and I got hit by the loss. So, when interest rates go up, mutual funds fall in value, and debt funds or bond prices go down.
When interest rates go down, bond prices appreciate exactly for the reverse reason that you are holding bonds, which will yield higher returns as of yesterday and before and future interest rates or future bonds will be issued at lower rates. So, they become pricey. So far, interest rates have been going up randomly, but now, we have come to a point where interest rates have stabilised. It looks unlikely that they will go up any further and looks likely that either it will stabilise and remain where it is, or there is a small likelihood that at some point, and not necessarily near future, but some foreseeable future or reasonable future, it will go down. When interest rates go down, some kinds of bonds appreciate in value much more than other kinds of bonds. Long-maturity bonds, because of the commitment or the promise to yield higher interest for a longer period, go up more because they promise to give you more returns and higher coupons for 15-20 years. So, the longer the maturity, the higher the appreciation. So, gilt funds - investing in bonds issued by the government - are free from any credit risk and are unlikely to default. They're also likely to honour every promise of giving you interest on time, and they also happen to be the only bonds that have longer maturity.
Corporate bonds are not available with longer maturity or as long as the maturity of a government bond of 10 or 25 years and so on. So, they do appreciate in value the moment interest goes up, and that could be an opportunistic investment for investors. However, normally, at Value Research, we have a slightly different, slightly passive, and slightly boring view of how to invest in bonds.
Who should invest in debt funds and why?
The primary reason should be the desire for stability and protection from market volatility. Debt investments, whether they're fixed deposits, debt funds, bonds, or Public Provident Fund investments, provide a portion of your portfolio with a cushion against market risks, offering stability and peace of mind. Every investor needs to have a fixed income allocation within their portfolio to ensure overall stability, regardless of market conditions.
Why debt funds vis a vis FDs?
Debt funds offer several advantages, including flexibility, the potential for higher returns, and tax efficiency. Investing in a debt fund allows you to defer taxes on gains until redemption and allows diversification.
How does one choose the best debt fund suited for their needs?
Choosing among the various categories of debt funds doesn't have to be complicated. For most investors, a conservative approach is advisable. Short-term debt funds are suitable for the majority, offering a balance between safety and returns. Liquid funds are nearly risk-free for those looking to invest for less than six months. For slightly longer investment horizons, short-term debt funds are recommended. For investors willing to take on a bit more risk for the potential of higher returns, long-term gilt funds may be considered, especially when interest rates are unlikely to increase.
Viewer's question
What is the best valuation metric or group of metrics that a simple retail investor should see before investing? - Rohansh
It's important to distinguish whether the valuation is for the overall market or a specific security. For individual securities, resources like Value Research Online provide valuation grades, historical price-to-book values, and price-to-earnings ratios. However, assessing the market's overall valuation can be more qualitative. Signs of exuberance in mainstream media or casual conversations about the stock market can be indicators of an overvalued market. Rather than trying to time the market, focusing on a disciplined asset allocation and periodic rebalancing based on your risk tolerance and goals is advisable.
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