Is it time to move out of debt mutual funds?

Few months ago, the IL&FS fiasco shook debt fund investors, this was followed by the commerical paper downgrades of Essel as well as DHFL. This led to fear among investors and many exited from their position in MFs that had substantial holdings in the papers of those companies. While investors were recovering from this hit, there came a new one and this time it was FMPs (Fixed Maturity Plans). Conservative to moderately conservative investors who usually opt for fixed deposits invest in FMPs. Many MFs had given loan to Essel group by pledging securities of Zee Entertainment Enterprises. But Essel has asked for extension towards the same till September 2019. So, either Essel would pay to MFs or MFs would sell-off the pledged shares to recover the amount. However, for those who are nearing their maturity would have to either accept partial money and rest of the money would be paid once it is recovered from the company or they can opt to extend their maturity period to any future date.

After looking at the above incidents’ investors have now started refraining from investment in debt funds. Earlier investors assumed debt funds to be safest. However, they are not at zero risk level. No debt funds assure guaranteed returns. Yes, they are safe when compared with equity, but not when compared with the bank’s saving deposit or fixed deposits.

Now the question is whether you should hold your current position in debt funds or take a call to exit from them? It is very important to understand that mutual funds are not a magical phenomenon that generates more return for zero risks. Savings bank deposits or other bank deposits carry zero risks, though it doesn’t mean that the bank cannot turn insolvent. However, banks run as per RBI norms where they have to maintain liquidity for such events of withdrawals.

Before quitting from debt funds it is important to understand what you wish. Do you wish to take zero risks and accept the lowest returns or accept some amount of risk and get higher returns than bank deposits? If the latter is the answer then remain invested in debt funds unless it has altogether turned to be a bad investment. Even if we look at it from a tax perspective then debt funds are more tax-efficient than bank deposits wherein debt funds get the benefit of indexation if redemption is mad after 3 years. So, while taking a call to hold or exit just understand what are the risks that you would be undertaking by investing in a particular category of debt funds and whether you are ready to take that amount of risk. If not, then investing in bank deposits would be a better idea.