Implications of Unchanged Repo Rate on Debt Fund Investors

Yet again, the Reserve Bank of India's Monetary Policy Committee (MPC) did not change the repo rate in its October 2021 review. As experts had anticipated, the repo rate holds steady at 4%. Such has been the case since May 2020. The Central Bank has kept the repo rate low and steady for more than a year to support economic growth.

Repo rate stands for the rate of interest at which RBI lends money to other banks. How does the repo rate personally affect you? It is key in swaying the interest rates of several financial instruments like loans, deposits and investments, especially debt funds.

Additional Read: 5 Reasons Why debt funds are crucial to your long-term portfolio in 2021

What does an unchanged repo rate mean for debt fund investment?

If you’ve been investing in debt funds for some time, you probably know how interest rate fluctuations influence this instrument’s Net Asset Value or NAV. When the interest rates in the economy bottom out, as is the case today, the likelihood of any new debt fund coming in at a higher Net Asset Value (NAV) goes up.

Therefore, the minute RBI raises its repo rate, bonds held within a new debt mutual fund will come with higher NAVs. Naturally, they will be more valuable and will likely earn higher returns for their investors.

Automatically, these funds will surge in demand, and investors would want to purchase them as soon as possible to benefit from relatively lower NAVs in the beginning. Therefore, mutual fund managers, presently, advise investors to make debt fund investments that carry a short maturity.

This means, look for top-rated funds like ultra-short duration funds, liquid mutual funds, and low-duration funds. If you want to park a significant amount of money and have an investment horizon of 3 to 5 years, you can also opt for medium-duration mutual funds.

Financial experts recommend this strategy for two reasons:

1. By the time the repo rates alter and newer debt funds with higher NAVs hit the market, your short-term debt mutual funds would have matured. And, you will have a lump sum ready to reinvest in more popular debt funds.

2. Secondly, just in case the repo rates change quicker than you had anticipated, you can hastily liquidate short-term debt funds and direct your corpus towards long-term debt funds. For this purpose, liquid mutual funds are an excellent investment as you can dissolve them rather quickly.

Lastly, if you want to diversify within mutual funds that offer a short maturity period, invest in a combination of liquid and money market mutual funds or dynamic bond funds.

Additional Read: Advantages of Having Debt Mutual Funds in Your Portfolio

To sum up

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