The performance of debt mutual funds is intertwined with interest rate movements as the latter have a significant bearing based on the funds’ yield-to-maturity. The duration of the funds also plays a role in this - debt funds with longer maturity periods are more prone to fluctuations in values due to changes in interest rates than short-term debt funds. Long-term funds have a greater duration and hence the chance is greater that interest rates will vary during its tenure as compared to short or medium-term funds which have a lesser number of interest payments. With shorter–term funds, the chances of drastic movements in interest rates are obviously lower.

Take the case of the financial crisis that rocked global markets in 2008 – yields declined as interest rates plummeted which boosted the performance of longer-duration and medium-to-long duration funds. On the contrary, between December 2016 and January 2019, yields went up and shorter duration funds benefitted. This is because in the case of short-duration funds, the proceeds from the short-term holdings get reinvested at a higher interest rate.

For debt fund investors, especially those who are new entrants to the world of investing, decoding and predicting interest rate trends can be tricky. However, debt funds, unlike equity funds, can provide sufficient returns and stability in a variety of market scenarios if investments in debt funds are made tactfully.

One way to do that is by spreading across investments in various debt fund categories with different maturity periods. For instance, medium-term funds like dynamic bond funds, banking and PSU funds and corporate funds can be great investment vehicles. In the case of corporate bonds the exposure to interest rate volatility is lessened because 80% of assets are invested in high-rated corporate bonds and returns are generated through the accrual of interest on bonds which are held until maturity and are of shorter duration. When it comes to banking and PSU funds, with 80% of the investments being channeled in debt instruments of banks, public sector undertakings, financial institutions and municipal bodies, the credit risk is substantially suppressed. In all these funds, the strategy is to help investors gain the most by striking a balance between mitigating risks and creating returns through accruals. Also, these funds ensure that investors do not have to worry about the credit quality of the underlying investments because investments are made in top-rated instruments.

Making investments into debt funds in accordance with prevailing and expected interest rate movements is not only extremely challenging but it can be extremely risky too. Interest rate fluctuations can be triggered by a host of factors, including some unexpected triggers and having an investment strategy that entails timing interest rate changes can be fallacious.

This is where SIPs fit seamlessly into the picture as they allow you to make the most of the potential of debt funds of different types with divergent maturity periods. The SIP in Debt route spares you of the trouble of having to actively track interest rate trends and thus curtails the room for error on the individual investor’s behalf.

With SIPs, you will be investing a fixed amount towards your debt mutual fund every month and thus allows you to reap the advantage of rupee-cost averaging which irons out the bumps created by interest cycles in the long run. When you invest at regular intervals you will end up investing at different prices created by varying market scenarios: you will be allotted units based on the debt fund’s current net asset value (NAV). If the NAV is low, more units are allocated in proportion to the investment amount and when the NAV goes up, lesser mutual fund units are allotted. Hence, it averages the costs at which you purchased units and acts as a buffer against market fluctuations. Additionally with SIPs, you can also inculcate the habit of investing diligently through the investment cycle and you can make the most of your debt fund investments irrespective of the interest rate scenarios.

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.