Is it the opportune time to exit long-term debt funds?

India’s benchmark 10-year bond yield is witnessing a continuous rise since late July 2017 and is currently at its 13-month high. It has increased from a low of 6.41% in the month of August to more than 7% as on November 19. The reasons for such rise in bond yields is the reversal of holy trinity of low crude, low inflation and low-interest rate that helped bond yields to fall. In addition to this apex bank of India, RBI’s large open market operations to mop up excess liquidity from the system is leading to rising in bond yields. Nevertheless, bond yield fell today (November 20) after RBI’s unexpected decision to cancel the open market sale of debt.       

For beginners, there is an indirect relationship between bond yields and bond prices. As bond yields go up, bond prices fall and vice versa. Return from bond funds comprises of interest income and capital gain (loss) due to change in underlying bond prices. Another important factor that determines the price of the bond is residual maturity, which means time left before the bond matures or are redeemed. Larger the residual maturity more will be the impact of the change in interest rate. Therefore, the price of the bond with longer residual maturity will get more impacted due to change or expectation of change in interest rates.

At the current juncture, when inflation is again increasing as we saw for the month of October 2017, it increased at a rate of 3.58% on yearly basis after rising by 3.28% for the month of September 2017. We feel there will be no rate cut in RBI’s next meeting in the month of December.

Against this backdrop, debt mutual fund schemes with medium to long-term maturity were the worst performer in the last one week and 3-month time frame. They have given a negative return of 0.41 per cent and 1.02 per cent, respectively, in the said period. Going forward, the bond yields are unlikely to come down sharply. This is evident from the temporary impact on bond yields after Moody's Investor Service upgraded India's credit rating to Baa2 from Baa3.

So, if you are holding debt fund gilt medium and long term, what should you do? Should you exit or wait for a reversal of interest rates? It depends upon your financial goal and investment horizon. If you have immediate requirement of the fund then it makes sense to exit. Nevertheless, if you do not require funds immediately and can hold for a longer duration, you can continue with your holding as we may see inflation stabilising and interest rates coming down. Nevertheless, if you are not sure about your goals and holding period and what matters is only returns, you can invest in debt funds that have a portfolio of short maturity debt instruments as they are still generating a positive return.