How will you benefit from investing early in mutual funds?

Fixed income allocation is critical to a portfolio’s performance. It is frequently utilised for liquidity, generating consistent income, and diversity. Having an adequate level of liquidity or emergency reserve is critical to the success of any asset allocation strategy. Investors should initially set aside a portion of their surplus as a liquidity buffer, which can be placed in low-risk debt instruments such as liquid funds.

Investors can choose from a variety of short-term to long-term duration funds, depending on their objectives and risk tolerance. It is crucial to note, however, that funds with a high credit risk may not be the best option for diversification.

So, which are the best duration funds investors can invest in the current scenario?

As with equities, the credit market does well when the economy is strong and struggles when the economy is not. However, high-quality bonds, such as government bonds, typically do well during periods of economic weakness. As a result, investors seeking diversification should adhere to portfolios of high credit quality.

“In the current environment, when there is a lot of uncertainty about the future economic prospects, it is essential to have adequate diversification. Interest rates are likely to move higher over the next 2-3 years period. Thus, investors should stick to low-duration funds to avoid high volatility associated with longer duration funds,” said Pankaj Pathak, Fund Manager-Fixed Income, Quantum Mutual Fund.

Concurred Shweta Jain, CFP, Founder of Investography: “I would go with the short term in the current conditions. The interest rates seem to have bottomed out, and I would like to wait till interest rates rise and then move to medium term or long duration funds.”

“There are possible inflation fears and doubts as to whether it is transitory or permanent in nature which can have a larger impact on the interest rates which in turn can significantly impact the debt and equity markets alike. Hence, investors can look at parking the majority of their corpus in short-term Bond funds, which will insulate them from the above concerns,” warned Tarun Birani, Founder of TBNG Capital Advisors.

Due to the RBI’s accommodative policy of lowering benchmark rates, bond fund returns have decreased over the last year. Bond yields are projected to remain in the same range for the next year, owing to the government and Reserve Bank of India’s (RBI’s) desire to promote economic recovery and sustained growth.

“Investors with a limited appetite for volatility should avoid taking exposure to long-duration funds and stay on the shorter end of the curve. Inflation is expected to average between 4.5-5% over the next one year, which will not push RBI for any rate hikes. RBI is taking active steps to manage yields and infuse liquidity which helps in keeping the benchmark rate in a tight range and avoids any credit stress during the pandemic,” said Deepak Khurana, Proposition Sales Director, Sustainable Finance & Lipper, Asia-Pacific at Refinitiv.

What should investors know about duration funds?

Debt Long Duration funds, Debt Medium to Long Duration funds, or Debt Medium duration funds) would be determined by a variety of factors, including the investor’s investment objective/goal, the rate of return on the investment, liquidity requirements, and risk tolerance.

For example, in comparison to long-term investments, medium-term or medium to long-term investments give the investor with greater liquidity. The longer the period of the debt investment, the less volatile it is and the greater the possibility for reliable return generation.

On the other side, returns may be altered by the period of the investment; for example, long-term investments may yield consistent returns due to their lower volatility. In general, short-term investments deliver a lower yield to the investor.

“Considering the existing pandemic situation, some of the investors may be facing liquidity issues and would be required to allocate more towards their emergency funds. Therefore, investors facing such issues may opt for the medium term or the medium to long term duration rather than blocking their entire capital in the long-term debt funds,” said Suresh Surana, founder, RSM India.