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Gilt and long duration funds’ returns turn negative

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The returns on some debt funds have been in negative territory in the past couple of months. The erosion is more pronounced in long-term and gilt funds.

The year-to-date category returns of long duration scheme are -2.32%. In the same period, dynamic gilt fund returns are -1.70%, and gilt schemes with 10-year constant duration fell -2.12%, according to data from Value Research.

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Debt funds are sensitive to interest rate movements. Last year, when the Reserve Bank of India (RBI) lowered the key policy rates, bond yields softened. Their prices rose, long duration and gilt funds had double-digit returns. That’s because bond yields and prices have an inverse relationship. When one rise, the other falls and vice versa.

Things have started to change post-Budget. “The government had said that it would maintain a high level of borrowing as it did during the previous financial year. Due to this, bond yields started firming up,” said Kaustubh Belapurkar, director of fund research at Morningstar Investment Adviser India.

For many, high government borrowing last year was an exception due to the covid-19 pandemic. If it continues at the same level, the fiscal deficit will continue to remain high.

Simply put, the government wants to sell a high number of bonds at low rates. But the bond market expects yields to rise further.

There are expectations that RBI will not lower rates further to keep inflation under its control. RBI has also withdrawn some of the liquidity measures it undertook the last financial year, which kept yields low. All these factors are leading to a rise in bond prices.

Will this continue? There is no clear answer. But as RBI is not likely to cut interest rates, the returns from medium-to-long term, long-term and gilt funds will be volatile.

“Investors should remain in short to medium term debt funds,” said Belapurkar. It is not a suggestion based on the current market situation. That’s the strategy investors should follow when investing in debt funds.

As gilt and long-term funds are sensitive to interest rate movements, investors should avoid them. Only those who understand the movement of interest rate, or have an advisor to guide them, should take a tactical call with limited funds.

It means an investor should be able to time the entry and exit in the long-term or gilt fund based on interest rate movement. It is something that even many experts cannot do. That’s why analysts and advisors are of the view that retail investors should altogether avoid gilt and long duration debt funds.

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