What do repo rate hikes mean for debt mutual fund investors?

Hikes in repo rates can affect debt mutual fund investors adversely. Know what it means for you and what to do to mitigate your losses.

Repo rate

Higher repo rates and what they mean

The debt mutual fund landscape has traditionally been viewed as a safe investing environment. Since last year, however, the RBI has hiked repo rates from 4.4% in May 2022 to 5.40% in August the same year.  

Currently, the repo rate stands at 6.50% and the reverse repo rate is at 3.35%. Let’s attempt to understand what they mean to you as a debt mutual funds investor? 

Read More: RBI Holds Repo Rate at 6.5%Highlights

  • The repo rate is the interest rate at which RBI lends money to other banks

  • Higher repo rate means borrowing becomes costlier for banks and inflation goes down

  • Reverse repo rate is the rate at which RBI takes loans from commercial banks

  • Higher repo rates mean a decrease in bond prices, leading to a decrease in the Net Asset Value (NAV) of debt funds, thus negatively impacting investors

Understanding the relation with an example

We know that repo rates and debt fund NAVs are inversely proportional.

Let's say that a debt mutual fund was issued with a coupon rate of 5%. The coupon rate is the annual interest rate that is paid by the issuer either annually, quarterly, or semi-annually. Now the RBI increases the repo rate.

This means that newly issued bonds will have a higher coupon rate, maybe 8%. This, then, forces reduction in the value of the previously issued bonds, making them less sought-after. 

What should you do?

As an investor, it's hard to see your life savings lose their value, but fret not. The rates move in an oscillatory motion and it's best if you put your faith in your investments and just wait out the rate hikes. Depending on the type of investment you made, some things can be considered:

  1. Short-Term Investments: If your investments are short term, you can consider your earnings to be relatively safe even with rate hikes. Once the maturity period is reached, you can reinvest in a different debt or equity instrument. Many analysts recommend that medium-term investments are also safe.

  2. Long-Term Investments: Long-term debt fund investors may see their fund value decrease. It is therefore important to invest in dynamic long-term funds that have a say in their lending duration. Further, the returns and maturity transparency should be enough to make you feel confident, even in the case of rate hikes. Given the longer duration, it is also possible that the changing interest rates will balance themselves out. Although many analysts believe that Repo rates may not come down soon, good quality funds with experienced managers won’t let you down.

That said, going for short and medium-term funds may be more appropriate in the current scenario. Gilt bonds that invest in government schemes are also an option.

Read More: Balance Risk and Returns With Volatility

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 Disclaimer: This article is intended for general information purposes only and should not be construed as insurance or investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.


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