Should you invest in debt funds with low past returns?

Debt funds are a popular investment option for many investors in India. They provide stable returns with relatively lower risk compared to equity funds. However, past returns should not be the only factor to consider when investing in debt funds. Here are some perspectives to help you make an informed decision:

Analyze the reasons for low returns

There could be valid reasons why a debt fund delivered lower returns in the past. Study the factors that impacted past performance before deciding to invest or not.

Declining interest rates – When interest rates fall, bond prices rise. But this leads to lower yields for funds holding bonds.

High credit risk – Funds holding lower rated or defaulted bonds will underperform in times of credit crisis.

Duration risk – Long duration funds tend to be more sensitive to interest rate changes.

Liquidity risk – Funds facing redemption pressure may need to sell bonds below fair value.

So analyze if the low returns were due to external factors or sub-optimal fund management. This will give perspective on future return potential.

Choose fund category wisely

Debt funds are not homogenous. Different categories carry different risks and return profiles.

– Low duration or banking PSU funds offer stable returns with low volatility.

– Corporate bond and credit risk funds aim for higher yields but with higher risk.

– Long duration funds are more sensitive to interest rate movements.

– Dynamic bond funds actively manage duration to capitalize on rate changes.

Compare funds within the same category when analyzing past returns. Returns for a banking PSU fund cannot be compared directly with a long duration fund for example.

Assess portfolio quality

Analyze the underlying portfolio quality rather than just past returns. Factors like credit rating, sector exposure, concentration risk, liquidity etc. determine the fund’s ability to navigate turbulent markets.

Prefer funds with higher credit quality portfolios. Avoid funds with excessive exposure to lower rated bonds or concentrated risky bets.

Examine portfolio maturity profile

The maturity profile indicates the embedded interest rate risk in the portfolio. Check weighted average maturity (WAM) and modified duration of the fund.

Higher maturity and duration implies higher volatility from interest rate changes. Choose funds aligning with your risk appetite and investment horizon.

Evaluate the fund management

The fund manager’s expertise plays a big role in debt fund performance. Analyze their investing approach, experience in various market cycles and risk management abilities.

Well managed funds may show temporary underperformance due to market conditions. But experienced managers tend to bounce back over full cycles.

Understand the interest rate outlook

Current bond yields reflect future interest rate expectations. When rates are expected to fall, yields tend to be low.

If the interest rate outlook seems conducive, funds providing superior yields can be considered despite low past returns.

Factor in taxation  

Debt funds enjoy tax efficiency compared to fixed deposits. Weigh post-tax returns based on your tax slab when comparing options.

Even if pre-tax returns were lower, debt funds may score higher in terms of post-tax yield depending on your tax slab.

Assess your own investment goals

Align your investment goals, time horizon and risk tolerance when choosing debt funds. Past returns alone should not drive investing decisions.

Conservative investors eyeing stable income can opt for low duration funds despite modest returns. Aggressive investors chasing higher yields may consider credit risk funds after analyzing the risks involved.

Avoid chasing short term performance

Don’t be swayed by flashy returns of certain funds in the last 1-2 years. Look for steady performance across market cycles.

Opt for well managed funds with a track record of generating superior risk-adjusted returns over longer periods. Stay invested for the long haul.


Don’t reject a debt fund only because of mediocre past returns. Do a holistic evaluation of portfolio strategy, fundamentals, risks, manager pedigree, taxation and your own investment objectives to make an informed investing decision and to find the best mutual funds.

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