Negative Returns by Liquid and Ultra Short term Funds

There are three categories of debt funds which are often used by retail as well as institutional investors to park money for the short term. These categories are Liquid, Ultra Short and Low Duration.

During the recent equity market fall, the debt markets were also becoming volatile and it resulted in negative returns by these very short term debt fund categories. It came as a shock to investors since these funds have not seen such a continuous downfall in the recent past.

With this blog, we will clarify the reasons for the recent fall in performance and recommend future action plans.

Volatility in 10 year G Sec Yield :

The prices of bonds in India move as per the 10 year G Sec Yield. If the G Sec Yield go up, then the bond prices move down and vice versa. Even though the short term debt funds are not completely dependent on 10 year G Sec yield, it is an indicator of volatility in the debt market in India.

Here’s how it moved over the last two months:

The worldwide pandemic of Coronavirus impacted the debt markets adversely. And hence, significant volatility was seen in debt fund movements.

Huge sell-offs from debt by FIIs

One of the reasons, Indian equity markets went down significantly over the last one month is Foreign Institutional Investors exited emerging markets in search of safe haven. But it did not just impact the equity markets. In debt markets as well, huge amount of outflows were due to FIIs.

Here’s how the FIIs net inflow/outflow looked like in the debt market:

In Number terms, over last month around 61,000 crores went out of the Indian debt market. This resulted in volatility in bond prices.

Redemption from debt funds by domestic companies

Indian companies invest their treasury money in debt funds. More specifically in Liquid, Ultra Short and Low Duration funds. Due to the lockdown in-country on account of coronavirus, the domestic companies will be forced to withdraw money from funds to take care of their working capital needs.

As of Feb 2020, the debt funds saw a net outflow of 28,000 Crore as institutional investors started existing from liquid funds.

In the near future, these factors will continue to put redemption pressure on debt funds and hence we might see some drop in the returns from short term debt categories.

What is the way ahead for retail investors in debt funds?

The next month may not provide any relief for debt funds as the country has gone into lockdown. So, the investor will have to be careful while selecting a debt fund.

If you want to invest for less than a month, then you may go with the Overnight fund category or simply put your money in a savings account. This is considering that capital protection will be the topmost need for such a time period.

For the investment horizon of 1-3 months, you can look at liquid funds. If your investment horizon is  3-6 months, Ultra Short Term Funds would be a better choice. For 6-9 months you can invest in Low duration funds.

If you are investing in any of these categories already and if your investment has given negative return, then please note that this effect may be there over 15-20 days period but as the coronavirus situation gets normalized, the returns from debt funds will also get back to normal.