How will the RBI policy impact your debt fund investments?

The RBI announced its monetary policy review on June 07th and along expected lines did not cut the interest rates. As a mutual fund investor in debt funds you may have wondered about the impact of these RBI policies on your debt fund portfolio. Here are some key pointers about how the RBI policy announced on 07th June can impact your debt fund investment decisions.

How the RBI guidance on Macro Economy will impact debt funds…

The RBI has guided inflation of around 5% for the fiscal year 2016-17 with distinct upside risks. This will impact the real returns on debt. For example if your nominal return on your debt fund is 9.5% and inflation is 4.5% then your real return will be 5%. Now if the inflation guidance has been raised to 5.3% then the real returns will stand reduced to 4.2%. That is a substantial fall of 80 bps in real returns. To that extent the attractiveness of debt returns goes down when inflation is guided higher.

RBI decision on interest rates and future guidance…

Normally your debt funds and income funds have a negative relationship with interest rates. When rates go down, the price of the bond will go up and when the rates go up, the price of the bond will go down. That is why bond markets always prefer a scenario of falling interest rates. This capital appreciation in bonds will translate into higher NAVs on debt mutual funds and the debt fund holder stands to benefit from the same. In this policy, the RBI has maintained status quo on rates. This policy has been more hawkish than previous April policy and a hawkish policy will mean higher yields on debt. This will translate into losses for debt fund holders.

Liquidity infusion and what it means for short term funds…

Rates are more critical for the debt funds at the long end of the yield curve. At the shorter end of the yield curve you have the call money market, Treasury bills, Commercial Paper, Certificates of Deposit etc. The yields on these instruments are a lot more vulnerable to liquidity. There was a liquidity shortfall of Rs.200,000 crore in the system 3 months back which has been brought down to Rs.65,000 crore by the RBI by infusing liquidity. This infusion of liquidity will lead to yields on call market, T-Bills and CPs trending lower. This will mean lower yields for those who are invested in money market funds and other short term funds.

Discussion on global factors and impact on your debt funds…

There are 2 key global factors that could impact your debt fund portfolio viz. US Fed Meet and the BREXIT vote. The US Fed in its meeting on June 15th is likely to decide on a rate hike. The latest jobs data coming from the US has been quite weak and that virtually rules out a rate hike this June. The RBI has put on hold its rate cut decision to get greater clarity on the US Fed action. If the US Fed on June 15th maintains status quo on rates, then the debt markets will expect a rate cut from the RBI in its August meet. This will bring down yields on debt funds and result in capital appreciation of these debt funds. Secondly, BREXIT is the possibility that Britain could exit the EU. This could mean that the UK£ will weaken versus other currencies if the British citizens choose to exit the EU. This could have negative implications for bonds issued by companies who have a major chunk of their billing in UK£. Debt fund investors will have to be cautious, especially of their corporate bond holdings.

Debt fund investing is not about buying and forgetting about it. Monetary parameters are very critical in determining the returns on these debt funds. As a prudent investor, one needs to keep a constant watch on such variables like inflation, interest rates, policy so as to be able to take a more informed view on debt fund investments.

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