With the recent demonetisation of Rs 500 and Rs 1000 notes, stock market may look confused but debt funds are really happy. For the benefit of our not-so-finance readers, debt funds are mutual funds, that invest the pool money in fixed income instruments such as bonds, T-bills, FDs, CDs etc. Simply put, debt funds loan the money to the government, banks, PSUs and private companies, for a fixed maturity and interest rates. You can read further on debt funds here.
How is the current situation good for debt markets?
First let’s understand what is likely to be the effect of the recent demonetisation on the economy. There are only two things that can happen to the rs 16.4 trillion of cash or 86% of indian currency (rs 500 and rs 1000 notes) that is demonetised –
- burned or thrown in the rivers
- deposited in the banks (tax paid or escaped).
Lets say 75% will be deposited in banks. So, banks will get ~ rs 12 trillion as deposits. And bank will not be able to lend so much money so soon. So they are going to buy as much of bonds possible.
Now the debt funds. Debt fund’s net asset value (NAV) depends on price of the bonds, etc. So, if suddenly every bank will be running to buy bonds this will push the bond prices high. This already started happening. Experts are expecting 5-10% returns in bonds within next 2-3 months. Keep calm and invest in debt funds before banks.
Should you move your portfolio from equity to debt?
If you are invested in equity for long term then you may continue in equity. The investments that you are planning to make in next 2-3 months, should be in debt funds for better returns in a short time. There is very high volatility expected in the equity market for next few quarters. If you have invested in equity for a short term, you should consider switching. Debt funds may provide better returns, by the time you redeem your money.