The Monetary Policy Committee of the Reserve Bank of India hiked the repo rate by 25 basis points to 6.25 per cent. A rate hike brings in a lot of anxious moments for debt fund investors, especially for those who have invested in long-term debt schemes.
Long-term debt schemes that invest in debt instruments with higher maturity get hit whenever the interest rates go up in the economy. Because of the inverse relationship between yields and prices of bonds, the NAV of these schemes falls whenever the interest rates go up. On the other hand, the return of short-term debt funds would be least affected by the rate hike.
What Should Be Your Mutual Fund Strategy?
You should stick to Short-term Debt Mutual Funds schemes and credit opportunity schemes if you see credit risk, because these schemes would invest in lower quality papers to earn more. Invest in long-term debt schemes and gilt schemes only if you have a long investment horizon and stomach for volatility in the short term.
If you have an existing exposure to long-term debt funds, you should wait for longer periods, i.e. around three years, for a change in the interest rate cycle. More hikes in interest rate would further bring down the return on long-term debt funds.
Equity mutual funds may also feel the heat due to increase in cost of borrowing for corporates. The stock prices may remain under pressure. As an Systematic Investment Plan (SIP) investor, you can remain invested in equity mutual fund. You can also consider investing in the arbitrage fund if you are averse to risk as an equity investor.
If you are a risk averse investor, ultra short term debt fund or short term debt funds could be a good choice at the moment to earn a low risk return.
You must not panic in the changed interest rate scenario. However, you can re-examine your financial goals and make changes in the investment strategy accordingly.
(The writer is CEO, BankBazaar.com. )