Debt funds: What are some of the best ones to invest in now?

The debt funds have suddenly come under the spotlight because of rising bond yields and the tax opportunity available before March 31, 2023. The yield to maturity (YTM) of debt funds has become attractive due to successive rate hikes and tighter liquidity conditions while there is a growing consensus that we are closer to the end of the rate-tightening cycle. 

“Investors with medium to long term investment horizon can look at funds having a duration of 3-4 years with predominant sovereign holdings as they offer a better risk-reward currently,” says Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund. 

Therefore, in the current scenario, one can consider investing in medium to long-term duration debt funds or dynamic bond funds.  Dynamic funds have, as the name suggests, dynamic duration. The dynamic debt fund cashes in on the changes in the interest rates to generate higher returns. These schemes are currently offering YTM of around 7-8 per cent. 

“With the peaking of the rate cycle, the possibilities of potential capital gains over a period of time can add to the total returns for the investor. Intermediate duration debt funds both with high grade as well as high yield portfolios are well positioned in the current environment to both capture the current high carry as well as sustain it in the near to medium term,” says Amit Tripathi, CIO – Fixed Income Investments, Nippon India Mutual Fund.

The post-Covid era has seen a full interest rate cycle playing out over a reasonably short period of time. The Fed Funds Rate have moved down and then up by a cumulative 675 bps while the effective Reserve Bank of India (RBI) policy rate has moved by a cumulative 495 bps in the last 3 years. 

“The effects of the aggressive front-loaded rate hikes by central banks are getting reflected in the banking system and we believe that we are at the end of the rate hiking cycle and it’s a very good time to invest into Fixed Income as bond yields have risen with real yields positive across the curve. The best time to invest in fixed income is when the rates are rising and in this context, we think this is the right time for investors to increase their allocation to fixed income as monetary tightening enters its last phase both in India and globally,” says Pal.

Tripathi further explains, “The sharp increase in policy rates and lending rates in the last few quarters have started showing some impact in activity numbers as well as inflation prints although from very high starting points. Trade data is indicating moderating demand conditions globally. Other macro and activity variables like employment and service sector PMIs will show the impact with some lag. Additionally, the recent events in the banking system in some of the large DMs will lead to credit tightening and declining credit impulse, which will further the slowdown narrative.” 

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