- Date : 09/02/2023
- Read: 3 mins
Increased repo rates and debt mutual funds
The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has hiked the repo rates consistently over the last year. Recently, on 8th February 2023, the rate was hiked again by 25 basis points (bps) to control inflation. This will affect interest rates in the markets, affecting debt investments. Let’s understand what you can do if you have debt funds.
Repo rates and inflation
The repo rate is the rate at which the RBI lends funds to banks. As the rate increases, it becomes dearer for banks to borrow from the RBI. As a result, banks hike their loan interest rates. An increase in loan interest rates discourages borrowers and helps control inflation.
Related - Here's a complete guide to RBI's repo rate
Repo rates and debt funds
When repo rates are hiked, interest rates on bonds and debt securities also rise, making them favourable for investors. As bond rates rise, the NAV of debt funds suffers. This is because the existing securities in the fund’s portfolio become less attractive as new securities become more favourable. The price of the bonds held in the portfolio fall, which leads to a fall in the NAV, leading to an overall reduction in the portfolio’s value.
What should you do?
If you are a debt fund investor or if you would like to invest in one, here are some investment tips for you –
- Short-duration debt funds
Short-duration debt funds can prove to be an attractive choice since these funds have short-term maturities. As repo rates rise and new bonds become more attractive, these debt funds can pick such bonds and give the benefit of better returns to investors. As such, short-term debt funds can be a good option. You can pick from liquid, overnight, ultra-short-term funds or funds with maturities going up to 3 years.
- Medium-duration debt funds
As the tenure increases, debt fund investors might lose from increasing repo rates. The debt fund would give lower returns as interest rates continue to rise.
- Long-duration debt funds
Long-duration funds might not be a good choice in rising interest rates. As such, you need to hold your investments in such funds. The overall yield might be similar to medium-term funds, so staying invested for longer does not give any additional value.
Though repo rates are meant to control inflation, they also affect the performance of debt mutual funds. Understand this effect and then make wise investment decisions regarding debt funds.
Related - Read whether FD investments make sense after repo rate hikes.
Check out this video to find out how increasing repo rates will affect your wallet.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.
