Debt mutual funds holding long duration bonds have gained the most in the past four months

After the insipid returns of 2022, when some debt fund categories delivered less than what a savings bank account offers, bond funds are on a roll. The benchmark 10-year government bond yield has slipped to a 12-month low in the past four months, dropping from a high of 7.61% on 26 June last year to 7.011% on 4 May. This decline has aided a rally in debt funds. The biggest gainers have been funds that hold long-term bonds. The SBI Long Duration Fund has shot up 5.85% in 2023, which works out to a return of 17.6% on an annualised basis. The fund holds bonds with an average maturity of almost 11 years. The Nippon India Nivesh Lakshya has given 5.2% (15.6% annualised) is the second best performer. It holds bonds with an average duration of almost 8 years. On average, the long duration bond fund category has delivered 4.89% returns (see table) in the past four months. This works out to 14.67% annualised returns.

This impressive performance comes after several months of sluggish growth. Long-duration debt funds performed abysmally in 2022 because of the sharp rise in interest rates. As RBI turned the screws on inflation the benchmark 10-year government bond yield rose from 6% in mid-2021 to 7.6% in June 2022. To a certain extent, short duration debt funds were cushioned from the impact of the hike in rates, but the long duration and medium duration categories were mauled. The worst performing debt fund category of 2022, the 10-year constant duration funds, yielded a miserly 0.8% during the year (see table).

The 10-year govt bond yield has hit a 12-month low

The tables have now turned, with long duration funds shooting up. However, for the rally to sustain, interest rates need to come down further. This is why experts recommend short duration funds that are not very sensitive to interest rate changes.

Debt funds are on a roll
After an insipid 2022, debt funds have shot up in the past four months.

Investors in target maturity funds should especially note that the spectacular returns earned in the past four months will not sustain. A relatively new category, these funds have done reasonably well in the past four months with 3.2% returns. Since target maturity funds hold their portfolio till maturity, the returns hereon will be muted.