Bond mutual funds were the preferred investment avenues for many investors until now because these offered protection from the vagaries of the equity markets. However, investors were in for a shock when yields suddenly shot up on July 16, following the measures announced by the Reserve Bank of India (RBI).
On Tuesday, the yields on the 10-year benchmark government security rose to 8.22 per cent, from the previous close of 7.58 per cent, a rise of 64 basis points. This means its price declined, because bond yields and prices are inversely related. Other bonds, too, saw a sharp rise in yields.
The impact was seen in the net asset value (NAV) of bond mutual funds. Longer duration funds such as income funds and dynamic bond funds had a bigger impact than short-term and ultra short-term bond funds.
According to data from Value Research, within income funds, Kotak Bond Plan A saw its net asset value (NAV) fall from Rs 35.17 on July 15 to Rs 35.03 on July 16. SBI Magnum Income's NAV fell from Rs 30.22 on July 15 to Rs 29.59 on July 16.
Within dynamic bond funds, SBI Dynamic Bond saw its NAV fall from Rs 15.29 to Rs 14.97 and Reliance Dynamic Bond saw its NAV fall from Rs 16.33 to Rs 15.87.
Within short-term funds category, the decline in NAV was not as much. For instance, ICICI Prudential Short Term Regular saw its NAV fall from Rs 24.59 to Rs 24.19, while IDFC SSI Short Term Regular saw its NAV fall from Rs 24.59 to Rs 24.28.
According to Hemant Rustagi, CEO of Wiseinvest Advisors, the impact of the rise in bond yields will vary depending on the kind of bond fund. "A lot of investors had invested in dynamic bond funds over the past few months. They may have seen a huge fall in their portfolios. In fact, those who came in the last six months may see a negative impact in their portfolios. However, RBI's action is short-term and at some point it would start unwinding these measures. So, investors should not panic and should stay invested," he advises.
In any case, since dynamic and income funds have time horizons of 18-24 months, investors should not lose focus of the time horizon. For those investors who have just started investing recently in bond MFs, after seeing the encouraging returns, Rustagi advises them, too, to have a defined time horizon of 18-24 months.
In a report titled A rude shock for fixed income investors', Dhruva Raj Chatterjee, senior investment consultant, India Morningstar Investment Management, says investors with high risk appetite can consider this extreme move as a buying opportunity and take a duration call through a dynamic bond fund or actively managed bond fund. However, investors who cannot digest volatility, and have a lower risk appetite, are better off with short-term and ultra short bond funds at this juncture.
Rustagi cautions investors should tone down expectations in terms of returns from bond MFs, compared to last year, because the interest rate cycle is expected to move downwards.
"These kind of hiccups generally occur after any sharp measure. Moreover, investors should draw comfort as these are actively managed funds and the duration is maintained according to the rate cycle. We expect the rates to stabilise over a period of time.'' says Sujoy Das, director and head of fixed income a Religare Invesco Mutual Fund.