Turn Of The Tide: Should You Invest In Debt Funds Now?

The past few years have been challenging for debt fund investors, but the case for adding them in your portfolio is now more compelling than ever

- Kundan Kishore

With equity investing catching the fancy of investors in recent years, especially after the Covid-19 pandemic, debt funds have often remained on the sidelines. This is the market to cash in on the bull run, as if it's a magical get-rich-quick formula.

It is also a fact that fewer retail investors really think about investing in debt funds. These usually include the ones who understand the importance of asset allocation in a portfolio, those who are saving for a short-term goal and retirees looking for a relatively safer instrument to park their corpus (see Why Should You Invest In Debt Funds?).

These investors saw their patience tested for the last few years as interest rates bottomed during Covid-19 as governments and central banks, including India's, tried to fight the pandemic and its aftermath by lowering rates. Usually, when rates are lowered, debt funds do well, but since foreign portfolio investors (FPIs) became net sellers, they suffered. From May 2022, the Reserve Bank of India (RBI) reversed its stance and as rates started going up, returns from debt funds took a hit as is usually the case. Now, with RBI keeping rates stagnant for about a year and expectations of a rate cut later in the year, the tides may turn for debt funds.

Does that mean it's the right time to buy debt funds? We try to answer that question by putting the Indian debt market in context for the last three-four years to enable you to make the right decision, and some others that are crucial for debt fund investing.

The Post-Covid Story

Debt fund investors got a rude shock when the interest rate bottomed out in 2020 but they didn't gain due to other factors. That year, when the pandemic struck India, RBI lowered the rate by 75 basis points (bps) in February and an additional 40 bps in May. This rate cut brought the interest rate to an all-time low of 4 per cent, remaining stagnant for around two years.