Debt funds have received increasing attention from individual investors in recent years given the market-linked returns, liquidity, tax benefits and transparency that they offer, and which make these more lucrative compared with traditional fixed investment products such as bank deposits. What these investors need to keep in mind, however, is that like their equity peers, debt funds too are capital market instruments and therefore prone to short-term volatility. A case in point is the negative returns in some categories of debt funds in the latest 3-month period, as the following table shows.

Unravelling the recent volatility

The recent volatility seen in long maturity debt funds is primarily an outcome of the sharp spike in yields in Jan-Mar, which pressured bond prices and, in turn, adversely affected the performance of the funds. The spike in yields was primarily due to wider-than-expected fiscal deficit estimates in the Union Budget 2021-22. Higher supply of government securities (G-secs), rising US Treasury yields and an increase in crude oil price pushed up the domestic yields.

Interest rate movements are one of the factors that influence the performance of debt funds. For instance, long-duration debt funds with higher maturity perform well when interest rates fall, while funds that follow accrual strategies do well when the rates remain flat or are high.