How Debt and Hybrid funds performed in Sep-23

What impacted Debt funds and Hybrid funds in Sep-23

What influenced the performance of debt funds and hybrid funds in September 2023. For debt funds, the two major factors were bond yield movements and the money market liquidity. Despite consumer inflation above 6% for 2 months in a row, the bond yields on the 10-year benchmark have been fairly stable over the last 2 months between 7.1% and 7.2%. That had kept bond fund returns steady There are concerns on the yields front. US bond yields at 4.6%-4.7% are at the highest level since October 2007. That could have an impact on India bond yields, although the surplus liquidity is neutralizing that. Debt funds at the short end have seen tepid performance, while arbitrage funds are making a splash.

On the hybrid funds, the story is more about equity exposure. Among the hybrid funds, it is the aggressive hybrid funds and the dynamic allocation funds (BAFs) that have done very well. In both cases, it is about a higher exposure to equity. In terms of inflows, it is the arbitrage funds that have been the star among the hybrid funds as they have offered investors a viable alternative with higher returns than liquid funds and greater tax benefits. Here is a quick take on the September 2023 story of debt and hybrid funds.

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Gilt (G-Sec) funds

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Gilt funds have seen fluctuations in the short term returns, but longer terms have remained stable. The leaders have been able to beat the benchmark by 80-100 bps on an average.

Corporate bond funds

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Corporate bond funds have been under pressure on returns due to variations in asset quality. The strategy of going down the rating curve has not worked too well in the past.

Credit risk funds

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Ideally, credit risks are intended to give higher long term yields compared to other debt fund classes, but that has not been the case.

Liquid funds

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Despite the surplus liquidity in the system the liquid fund returns continue to be attractive for the investors, which shorter terms turns outperforming the longer term returns.

Balanced funds (aggressive)

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

If aggressive balanced funds have done well, it is largely due to the higher allocation to equities. Most aggressive allocation funds have an equity portfolio that mirrors multi-cap funds and that has worked in favour of these funds.

Balanced funds (conservative)

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

The difference in long term returns between aggressive and conservative funds is the equity exposure and that is where the returns on conservative funds are lower. However, its ability to sustain these returns over a longer time frame is proof of the merits of asset allocation.

Dynamic asset allocation funds (baf)

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Most dynamic funds or balanced advantage funds have tilted towards equities in the last couple of years. To that extent, many of the portfolios of these BAFs have started to largely mirror the aggressive balanced funds.

Arbitrage funds (cash-futures)

Top performing Direct Plans (Growth Option) on 5-year returns (as on 30th Sep-23):

Arbitrage funds have been attracting the maximum flows in recent months among hybrid funds. It is the combination of stock market volatility and high bond yields that is causing the arbitrage spreads to go up sharply. The additional tax benefits of an equity fund are icing on the cake for arbitrage funds.

What we read from non-equity funds in September 2023

Some interesting thoughts emerge. Hybrid funds have gained from equity exposure, but also from asset allocation. For most non-equity categories, the leaders continue to beat the benchmark indices over a 5-year period, notwithstanding short-term fluctuations. However, as stated earlier, the US bond yields at 4.7% is a risk to Indian bonds, as are the prospects of a US shutdown. But, even in the case of non-equity funds, the winners have been consistent as a category. So, even in case of non-equity funds, past returns are a good reflection of the future. That makes fund selection a lot easier for investors.