Here's when you should invest in debt funds

Below is the verbatim transcript of Roongta's interview with CNBC-TV18.

Caller Q: Need a clarification on the relation between debt funds and interest rates and whether it is a good idea to invest in debt funds?

A: The relationship between interest rates and the price of a bond is inversely related. These are very commonly used terms. However, I will explain this in simple words, for example if you have bought a five year bond of Power Finance Corporation with a face value of Rs 100 and the coupon rate being 10 percent so you earn Rs 10 as interest rate every year.

If interest rates in the market fall down to 8 percent and you wish to sell your bonds. You will not sell your bond at Rs 100 for the simple reason that the entitlement of interest on your bond is 10 percent but in the market it is 8 percent so you will command a premium, you will sell these bonds at Rs 108 so Rs 8 being your profit.

Similar is the function of a debt fund; the debt funds have two source of income, one is the accrual of interest on the paper that you are holding and the other is a capital gains, in case you make if the interest rates are falling. Considering the current situation wherein you have seen depreciation of the rupee, current account deficits; it is difficult to see that interest rate will soften from here immediately. So, the exceptional gains which debt funds have given over the last one year or two years may not repeat in the next six-eight months from now unless you see interest rate falling. Therefore, an advice to you and other investors who are looking to make money out of the interest rate movements by investing in debt funds, I think you should take a cautious view and concentrate on investing into debt funds only if your debt allocation permits you to do that.

Q: If someone is already invested into a debt fund, do you suggest they redeem now because you are not expecting too much of gains going ahead?

A: Not really. I would suggest to be invested because one will not see exceptional gains coming immediately but one will see interest rates over a longer period of time, which is one year and above have to come down; a growing economy like ours cannot sustain at these high interest rate levels. Therefore, one will eventually see interest rates coming down. If it is a part of debt allocation then surely remain invested in it.