As of January 30, 2025, several debt funds have shown impressive 1 year returns, with some even outperforming the SBI Nifty 50 ETF (9.26%):
Debt Fund | Category | 1 year return (as on Jan 30, 2025) |
Quantum Dynamic Bond Fund | Dynamic Bond | 9.47% |
SBI Magnum Gilt Fund | Long Term Gilt | 9.38% |
HDFC Corporate Bond Fund | Corporate Bond | 8.91% |
HDFC Medium Term Fund | Medium Term | 8.81% |
Bandhan Corporate Bond Fund | Corporate Bond | 8.07% |
Axis Treasury Advantage Fund | Low Duration | 8.00% |
SBI Low Duration Fund | Low Duration | 7.81% |
HDFC Liquid Fund | Liquid | 7.38% |
Parag Parikh Liquid Fund | Liquid | 7.06% |
SBI Nifty 50 ETF | Equity - Large Cap | 9.26% |
Surprise!
Some debt funds are head of the Nifty 50 in the past 1 year. Hopefully, this reminds you about the power of asset allocation.
Not just that these debt funds are probably head of a lot of other fixed income options in the market including small saving schemes.
And now what if I told you that these numbers are likely to go up in the near future.
There is a simple math to it.
Understanding Debt Fund Mechanics
Debt funds' Net Asset Value (NAV) calculations consider expected cash flows until maturity. Here’s a simple example:
If you buy a bond for Rs. 100 that yields 8% annually, but market rates rise to 10%, selling this bond becomes challenging because new investors could get a better return elsewhere. To sell, you might have to lower the price to match the new yield, perhaps down to Rs. 80.
The inverse is also true:
When interest rates fall, the NAV of debt funds increases as the fixed income portfolio benefits from the appreciation in bond prices.
You see, in the investing world, there is an inverse relationship between price and interest rates. How much the impact is depends on the kind of portfolio the fund holds. The longer the duration in the portfolio, the bigger the impact is.
In the table above, you are looking at the range of the impact:
Shorter duration (e.g., liquid funds with 90-day maximum maturity): Lower impact
Longer duration (e.g., long-term gilt funds with up to 30-year bonds): Higher impact
Market Context
We've seen a cycle of interest rate changes:
Covid period: Rate reduction
Post-Covid: Rate increase
Current phase: Rates declining again, suggesting potential higher returns ahead
The TAX hurdle
Until March 31, 2023, debt funds benefited from long-term capital gains tax with indexation, allowing a 20% tax after indexation for holdings over 36 months (later reduced to 24 months). However, post the budget on July 22, 2024:
Indexation was removed for all asset classes except immovable property.
Long-term capital gains tax was set at 12.5% for most assets, but debt funds lost this benefit if purchased on or after April 1, 2023.
But debt funds or bonds funds were dealt the biggest blow. No more long term capital gains tax benefit if you bought your fund on or after April 1, 2023.
So, if you have held your debt funds from before March 31, 2023, you still get to enjoy 12.5% long term capital gains tax after 24 months of holding.
Everyone else: please pay tax as per your tax bracket. The only saving grace is that you pay tax only when you sell and realise the gains.
If your tax bracket is not a hurdle, this can be a great time to benefit from the upcoming, dare I say, double digit, spike in debt fund returns.
Note: While pure debt options have their advantages, there are other tax-efficient investment strategies available, though they may not be 100% bond-based.
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