Debt fund strategy is designed keeping in mind several key factors such as interest rates, tax implications, investment duration, risk tolerance and market trends. In the current scenario, investors should consider a tactical approach towards their investments in debt funds, keeping in mind the expected fall in interest rates.
The year 2024 could be favorable for the bond market, as central banks are expected to lower their key rates. The amount and timing of rate cuts will vary from country to country depending on the state of their respective economies.
“As for India, we believe the RBI may consider rate cuts from October 2024 after taking an in-depth look at factors such as the new Union Budget, current inflationary pressures, dynamic global growth-inflation and the policy rate environment. » says Dhawal Dalal, CIO-Fixed Income at Edelweiss MF.
So one strategy would be to invest in long-term debt funds or dynamic bond funds with a modified duration of 7 to 11 years. The anticipated decline in interest rates can provide potential capital appreciation of 8-10% in addition to yield to maturity (YTM). This presents an opportunity for investors to book profits and pay their marginal tax at the time of redemption.
“Tactical Call on Interest Rates – Investing for Long Term – Long Term Debt Funds and Dynamic Bond Funds with modified duration from 7 to 11 years. Interest rates are expected to fall by 75 to 100 basis points over the next 12 to 18 months. The expected decline in interest rates can result in capital appreciation of 8-10% on top of the YTM. Investors can book profits and, upon redemption, pay their marginal tax rate. Invest in Medium Term Bond Funds – This segment is also attractive from the perspective of generating additional return through capital appreciation with less risk compared to long duration funds.
Mid-term bond funds also hold value, providing additional returns through capital appreciation with lower risk compared to long-term funds. This results in a reasonable margin of safety despite potential market volatility,” said Rajul Kothari, partner Client Associates, a specialist wealth management firm.
Debt funds mainly focus on investing in fixed income securities such as government or corporate bonds and money market instruments. The prices of these securities are directly affected by changes in interest rates because bond prices and interest rates are inversely proportional. When interest rates rise, prices of existing bonds fall and funds must assess their net asset value (NAV) in the market on a daily basis, and therefore MTM losses.
Pursuing investments in short and medium term debt funds, including corporate debt funds, can also be beneficial. These higher yielding options help with diversification and stable income through systematic withdrawal plans (SWP). They also offer liquidity, professional management, flexible withdrawal options and defer taxes until redemption. This is in contrast to fixed deposits (FDs) and bonds, where tax is payable on the interest incurred every quarter or financial year (FY).
“Fixed income investors can consider investing in mutual debt categories, namely medium duration funds, corporate bond funds and bank and PSU debt funds. Medium duration funds maintain an average maturity of between 3-4 years, while corporate bond funds mainly invest in papers issued by the highest rated entity and bank and PSU funds mainly invest in papers issued by banks and PSUs which offer a higher level of security. (Securities issued by banks and PSUs have higher ratings),” said Rajiv Bajaj, chairman and managing director, BajajCapital.
It should be remembered that capital gains on debt funds can be offset by short-term losses from other investments.
Additionally, the ease of debt fund transactions, as opposed to buying bonds or other fixed-income securities, which require demat and brokerage accounts, adds to their appeal.
It should be noted that new investments in existing debt fund schemes should be made in a new folio. It protects the tax benefits of previous investments.
Repayment of debt funds is carried out on a first-in, first-out (FIFO) basis. Therefore, if new investments are made in an old portfolio, the oldest units, which benefit from the previous tax regime, will be bought back first, leading to potential tax disadvantages.
In conclusion, despite the changes in tax laws, debt funds remain an attractive investment option for various reasons. Conscious and strategic investing will help manage dynamics, promising sound financial planning.
