Investors fear sustained rate hikes, switch to liquid and overnight funds

G-sec yield has remained under pressure in the past few days due to the concerns over rising inflation and crude oil prices

Open-ended debt funds witnessed sharp outflows in May, led by high redemptions from the money market and short-duration funds. The data from the Association of Mutual Funds in India (Amfi) shows there were net outflows worth Rs 32,722.25 crore from debt funds last month.

Categories like overnight funds and liquid funds, on the other hand, saw net inflows of Rs 15,070.89 crore and Rs 1,776.88 crore, respectively, in May. Money market funds witnessed net outflows of Rs 14,598.65 crore; the figure for short-duration funds was Rs 8,603.03 crore.

Amid expectations of more rate hikes by the Reserve Bank of India (RBI) to tame inflation, market players are suggesting investors stay invested in very-short duration funds.

Rising food, commodity, and fuel prices — among other macro factors, such as the war in Ukraine — led to a 40-basis point rate hike in May. Kavita Krishnan, senior analyst-manager research, Morningstar India, says: “Given the current scenario and the broader market expectations, most categories of debt funds are witnessing outflows, except overnight and liquid funds. Single-digit returns and a marked preference towards other asset classes, such as equities, also appear to have impacted flows into debt funds.”

The yield on the 10-year government security closed on Monday at 7.60 per cent against Friday's closing of 7.52 per cent. The yields on government securities have remained under pressure in the past few days due to concerns over rising inflation and oil prices.

Typically, the prices of fixed-income securities are dictated by prevailing interest rates. Interest rates and prices are inversely proportional. When interest rates decline, the prices of fixed-income securities increase. Similarly, when interest rates are hiked, the prices of fixed-income securities come down.

According to market participants, the rising interest rates, a volatile macro environment, and higher yields have likely impacted investors' investing preferences within the debt markets.

In May, even categories, such as ultra-short duration funds, low-duration funds, and dynamic bond funds, witnessed net outflows.

The data from Value Research shows that liquid and overnight funds have given returns of 0.93 per cent and 0.92 per cent, respectively, in three months. Funds with higher maturities, such as corporate bond funds, medium-duration, and gilt funds, have given negative returns during the period under review.

Akhil Mittal, senior fund manager, Tata Mutual Fund says: “The capital markets (debt funds) are currently much better priced as compared to the previous two years. In fact, the capital markets' pricing for risk-free rate is significantly higher than most bank FD rates. So, debt funds are expected to provide much better accruals. At the same time, given uncertainty on expected inflation, high fiscal and current account deficit, the longer end of the curve may remain volatile.”