A thread on the elephant in the room. Why are my long term debt fund returns negative over the last few weeks or month?

Many investors have bought debt fund products - gilt, medium and long term debt funds, Bharat Bond, and long term roll downs (including the Edel BPSU and other products). The returns for this funds are negative over the last few weeks.

This causes worry and I believe unfortunately our levels of understanding on debt funds and debt risks are weaker than equity funds. Given everything that has happened it is also easy to assume because fund returns are negative something is structurally wrong. Not true.

This thread attempts to explain the facts and nuances. Unfortunately some of these debt fund purchases happen looking at last 1 year returns which in any form of investing is a bad idea. It is also unfortunately inevitable.

Your debt fund returns move with interest rates. When rates move down, your fund returns move up. When rates move up, the reverse happens. Rates have fallen in the last year which is why past returns look good. Rates have risen recently which is why the negative returns.

Movements in rates affect long term funds with high duration much more than short term funds which is why you don’t see pain in your short term funds. Broadly a fund with duration of 7 means a 1pc rate move leads to a 7pc MTM.

This is mark to market return and you should not panic. There is no credit issue or default driving this. Now note within debt funds there are two kinds of funds - active duration funds and target maturity or rolldown funds.

In active duration funds like gilt your final return does depend on rate movements. This is why I always find gilt funds tricky because no one can predict interest rates well and we usually don’t.

In target maturity or rolldowns like Bharat Bond or the 10 year rolldowns in the market, the fund’s duration declines over time. If you are a hold to maturity investor you will see a yield close to the YTM yield if you hold. The volatility is just mark to market.

That’s why such structures are popular, because you can match your tenure to the maturity of the fund, and have an FD like holding people experience.

What should investors in these funds do? One don’t panic, and don’t redeem because of short term returns. Particularly if you are in target maturity or rolldown structures realise it is an MTM issue.

For fresh investors, rising yields is an opportunity. This is a chance to look in rates at higher level in target maturity / rolldown structures. And finally, do remember again that investing basis last one year returns is dangerous.

Happy investing!

For those who want a detailed understanding of why interest rates move bond prices, here is a simple attempt. Thanks @rajivmehta19 for mentioning this. https://twitter.com/iRadhikaGupta/status/1259377562309914630?s=20