1. Investing in a debt fund is quite different from doing so in a fixed deposit.
2. In the case of a fixed deposit, the investor agrees to an unrealistic freeze in rupee return, in exchange for convenience and simplicity.
3. However, in the case of a debt fund, the government does not determine interest rates in our economy, nor are they dictated by powerful institutions.
4. We have transitioned to a market for interest rates, and this market enables money to be lent and borrowed based on the needs and views of a large number of participants.
5. In such a market place, there are only prices and clearing, and there is no right or wrong.
6. The market just brings a borrower and lender together and enables the clearing.
7. Alternatively, the borrower might be in the market today believing that the rates are set to rise and, therefore, wanting to borrow today; the lender might be in the market with a view that rates are set to fall and, therefore, eager to lend.
8. When an investor chooses a bank deposit, he does not select the market.
9. This is the reason he settles for a lower rate on his savings bank account, while the bank itself would be lending its surplus balance for a higher interest rate in the call market.
10. When such an investor chooses a debt fund, he simply steps into the market place for borrowing and lending.
11. In this market, the rates change dynamically based on demand and supply and the views of various players across the globe.
12. What is in the market is what he gets.
13. A debt fund also pools in money and creates a portfolio much like an equity fund, except that it buys debt securities issued by governments, banks and companies.
14. Since a debt fund is an open-ended product in which investors can come and go as they please, it accounts for the interest income on a daily basis, and the Net Asset Value has to correct to a new value.
15. This is the market risk in debt funds.
16. Interest rates change:
a) if market participants expect inflation to change, they will modify their expectations for rates.
b) if they desperately need money, they will offer a high rate, as they do in March every year.
c) they may seek a different rate given their preferences arising from their own balance sheets.
17. These changes are anticipated, tracked and acted upon by market participants and reflect in prices, which can sometimes change unexpectedly due to domestic and geopolitical reasons, e.g. rupee’s depreciation against the dollar for geopolitical reasons.
18. Then, the value of debt securities in the portfolio of debt funds will also change accordingly.
19. A debt fund’s steady accrued income may not be enough to cover steep changes in the value of bonds arising from variations in interest rates.
20. The funds with longer tenors have too many cash flows in the future and, therefore, correct more when the interest rates increase.
21. The shorter tenor funds typically correct less when the rates change.
22. However, if the change is both unexpected and steep, the correction is significant.
23. Some investors will continue to dislike market risks and seek deposits; others will take the ups and down in their stride as long as they know the pricing is fair.
24. Each to his own.
2. In the case of a fixed deposit, the investor agrees to an unrealistic freeze in rupee return, in exchange for convenience and simplicity.
3. However, in the case of a debt fund, the government does not determine interest rates in our economy, nor are they dictated by powerful institutions.
4. We have transitioned to a market for interest rates, and this market enables money to be lent and borrowed based on the needs and views of a large number of participants.
5. In such a market place, there are only prices and clearing, and there is no right or wrong.
6. The market just brings a borrower and lender together and enables the clearing.
7. Alternatively, the borrower might be in the market today believing that the rates are set to rise and, therefore, wanting to borrow today; the lender might be in the market with a view that rates are set to fall and, therefore, eager to lend.
8. When an investor chooses a bank deposit, he does not select the market.
9. This is the reason he settles for a lower rate on his savings bank account, while the bank itself would be lending its surplus balance for a higher interest rate in the call market.
10. When such an investor chooses a debt fund, he simply steps into the market place for borrowing and lending.
11. In this market, the rates change dynamically based on demand and supply and the views of various players across the globe.
12. What is in the market is what he gets.
13. A debt fund also pools in money and creates a portfolio much like an equity fund, except that it buys debt securities issued by governments, banks and companies.
14. Since a debt fund is an open-ended product in which investors can come and go as they please, it accounts for the interest income on a daily basis, and the Net Asset Value has to correct to a new value.
15. This is the market risk in debt funds.
16. Interest rates change:
a) if market participants expect inflation to change, they will modify their expectations for rates.
b) if they desperately need money, they will offer a high rate, as they do in March every year.
c) they may seek a different rate given their preferences arising from their own balance sheets.
17. These changes are anticipated, tracked and acted upon by market participants and reflect in prices, which can sometimes change unexpectedly due to domestic and geopolitical reasons, e.g. rupee’s depreciation against the dollar for geopolitical reasons.
18. Then, the value of debt securities in the portfolio of debt funds will also change accordingly.
19. A debt fund’s steady accrued income may not be enough to cover steep changes in the value of bonds arising from variations in interest rates.
20. The funds with longer tenors have too many cash flows in the future and, therefore, correct more when the interest rates increase.
21. The shorter tenor funds typically correct less when the rates change.
22. However, if the change is both unexpected and steep, the correction is significant.
23. Some investors will continue to dislike market risks and seek deposits; others will take the ups and down in their stride as long as they know the pricing is fair.
24. Each to his own.