Debt Fund Opportunities

To understand how debt mutual funds react to increases in the repo rate, we analysed a few past occurrences when the repo rate was increased. We attempted to figure out the performance of debt funds three months previous to the increase in the repo rate, as well as three months, six months and one year following the increase in the repo rate

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In the quarter ending March 2020, the stock markets saw a free fall and, in the process, wiped out about 40 per cent of the equity market investor's wealth. The stock market, seen as a leading indicator of the economy, sensed that the pandemic-induced lockdown will cause a disruption in economic activity. This will have a significant influence on the economic growth of not just India, but also the entire world. To minimise the adverse impact of such a drastic slowdown in economic activity, the Reserve Bank of India and other central banks across the world flooded the system with liquidity, cut policy rates and thus decreased the cost of borrowing wherever possible so as to empower people to spend more. In truth, the tale of rate cuts in India has been pre-pandemic. When we look at the repo rates since 2018, we can observe that they have taken a downward trajectory.

As interest rates fell, individuals who invested in long-term bonds or funds that held the bulk of long-term bonds benefited on a mark-to-market basis. This can be seen in the table (Median returns (%) of debt fund category from August 2018 to May 2020) where we see most of the long duration-dedicated funds generating returns in double digits.

That said, economic recovery has made substantial headway in the recent year. As we reach the year 2022, it appears to be a true post-pandemic world with active cases dropping dramatically across the country and economic activity fast catching up to the pre-pandemic level. The side-effect of lockdown, huge stimulus and V-shaped recovery in economy is leading to higher inflation. This is posing the RBI a new difficulty in managing inflation, which was 6.07 per cent as of February 2022 – somewhat higher than the RBI's target range of 4-6 per cent.