The last
few weeks have been extremely turbulent and volatile for the financial markets
- stock markets have been moving up and down in crazy frenzy moves, bond yields
have been galloping upwards resulting in falling bond prices, precious metals
(gold and silver) hitting new multi-year lows while the Indian rupee hitting
all time life time lows. The striking of them all is the realization to many a
fund investors that they have lost money in Income / Debt / Bond Funds. Yes,
it’s very difficult for a fixed income investor to digest the fact of losing
his capital.
You don’t
make money from Income Funds because of:
Interest Rate Risks
Although
the name is Fixed Income securities, there are different types of risks while
investing in them like credit risks, interest rate risks, yield curve risks, liquidity
risks and basis risks. A very misunderstood, formidable, unquantifiable and
underrated risk is “interest rate risk”. This risk is directly related with the
maturity of a security – the longer the maturity the higher the risk (and
return). For long dated fixed income securities, when interest rates increase
the price of the bond decreases and vice versa. Therefore, if you invest in
Income Funds during an increasing interest rate environment then the value of
the fund is likely to depreciate.
Absurd outdated advise from Fund Advisors
Investments
in income funds should ideally be done when the interest rates are high because
of dual factors – firstly, the inherent yield of the income fund would be elevated
which will ensure high accrual income and secondly, if interest rates are
currently high then other things remaining constant, there is more likelihood
of it going down in the future. However, unfortunately income funds are generally
not marketed when interest rates are high but are actually promoted when
interest rates have already moved down because when interest rates have already
softened in the near past, the return from Income Funds would be unsustainably
super normal which would look further bloated when it is incorrectly annualized.
Fund Manager Bias
Any
fund manager hates when his fund underperforms. And the fund manager would
certainly not like when there is negative return on a debt product like an
Income Fund. Hence, during an increasing interest rate environment, the fund
manager would unjustifiably reduce the maturity of the fund and start managing
an income fund like a short term plan going against the very mandate of the
fund itself.
Poor Performance does not come
cheap
Income Funds
are nothing but interest yielding debt products. But, when someone deducts high
fees from the interest rate then what would happen – substantial fall in the
income yields. That is what happens with Income Funds which are loaded with
high fund management expenses. After all, poor performance does not come cheap!
Conclusion
There are
some distinct advantages of investing in Income Funds like tax arbitrage since
return on growth funds is treated as capital gains as compared to interest
income in the case of bank fixed deposits and hence subject to lower tax rates
along with indexation benefits, a chance to ride the interest rate cycle,
invest in GSecs etc. However, your success with Income Funds, like any other
investment would depend on dual factors. Firstly, the entry point of your
investment – timing is very important while investing in Income Funds, if you
invest just before an increasing interest rate cycle then unfortunately it
would take many months or even couple of years to regain by way of interest
accrual the capital which you might have lost. Secondly the exit point, Income
Fund like any other product is not an investment for the long term, once you
ride the downward shift in the yield curve, it is time to pack your bags, book
your profits and get out of it.
To
conclude, learn to ride the interest rate curve earning above normal profits
from your Income Fund investments and not allow the fund manager or advisor to
have a ride with your money.
