What are the factors to consider while investing in debt funds?

Can the NAV of debt mutual funds act as a guide for investment? Or should we also look at interest rates, yields, and duration of investment of debt funds while investing?
--Anmol Sharma


The NAV of the scheme in isolation doesn’t tell you much about a scheme. It is the value of the investments made by the scheme. It is extremely important to understand the interest rate environment and how rates are likely to move in the near future. For example, we are entering a rate tightening cycle. Sure, the RBI hasn’t increased interest rates yet, but money market analysts believe it may be forced to hike rates soon. As you know, rising interest rates is bad news for debt mutual funds. In such a scenario, long-term debt funds are likely to post losses. Even short-term debt funds are likely to witness some volatility. That is why mutual fund managers have been asking investors to stick to debt mutual funds.


Having said that, it is extremely important to choose debt schemes based on your investment horizon. For example, you should stick to liquid funds if you are investing for a few weeks or months. Or you can invest in Banking & PSU Funds, corporate bonds funds, floating rate funds, among others if you are investing for three years. Don’t go by the Sebi definition alone while choosing a scheme, pay attention to the modified duration of the scheme. For example, a fund manager may opt for shorter instruments to reduce volatility when he thinks the rates are likely to go up.

Do not chase returns. Always choose a scheme based on your investment horizon. Place a lot of importance on credit quality of investments. Never expose yourself to unwanted risk when you are investing for a short period of time in debt funds. Invest in long-term debt funds and gilt funds only if you can tolerate volatility and have the patience to go through the entire rate cycle.