Debt mutual funds have been down and out for the count with poor returns for not one, but two years now and worse still, no visibility of any revival on the cards. Most debt fund categories have not only not performed well in the calendar year 2021, but also failed to match even the returns of bank fixed deposits.
Hence, even after factoring in the tax arbitrage for investors in the higher tax bracket, many investors seem to have returned to their older debt investment avenue of bank and corporate fixed deposits. If not a higher rate, these products at least provide far better visibility to these investors.
Investors from the fixed income category but less averse to risk than traditional debt instrument investors have begun to explore and some have migrated to hybrid funds, especially of the lower risk variety that carries an in-built hedge mechanism.
Some with no aversion to their funds being locked in for a while have even found solace in innovative insurance products that provide similar or even higher returns, while at the same time offering the additional dual advantage of an insurance cover and tax-free returns.
One exception is the category of debt mutual funds where, as mentioned earlier, the returns have been dismal in recent times, has been the credit risk category. Some of the credit risk funds have delivered 9% returns in the twelve-month period up to around the end of January 2022).
Interestingly, that has not deterred investors from redeeming their money from these funds. To cut a long story short, the category’s Assets under Management (AUM) which stood at Rs 55,000 crore plus around two years ago stood almost halved to around Rs 28,000 crore by the end of the calendar year 2021.
Now, there have been some reports about investors who are open to taking additional risks being asked to consider a credit risk fund in lieu of an equity fund. This is puzzling as the risk profile of investors in these two categories cannot be compared.
Of course, within the debt mutual fund investing space, an investor who is not only aware of the additional risk he is taking to secure the potential additional return can allocate a modest portion of his portfolio to credit risk funds.
The tightening of norms in the debt mutual fund category post the Franklin Templeton fiasco has probably reduced the risk factor but that could also simultaneously impact returns going forward as risk and reward invariably go hand in hand.
Furthermore, the above-mentioned fiasco has led to a visibly more conservative approach by fund managers in this category as the fear of the fallout of defaults is now far higher than it was earlier.
Clearly then, the debt mutual fund sub-segment has a lot of work to do before they regain their preferred investment status among fixed-income investors, and the complex capital gains tax structure in the segment is yet another obstacle in its way that needs to be surmounted.