Gloomy season for debt funds?
Over the past few months, the mutual fund industry exuded confidence, thanks to massive additions to mutual funds folios, including women and first-time investors, and huge inflows. The Assets under Management (AUM) zoomed. However, hidden behind these positive numbers are signs of uncertainty. For example, according to data released by the Association of Mutual Funds in India (AMFI) on October 10, debt mutual funds recorded heavy net outflows of more than Rs 1,00,000 crore in September, a sharp jump from under Rs 8,000 crore in the previous month.
Out of the 16 debt fund segments, 12 reported net outflows during September, with liquid, money market, and ultra-short-duration funds contributing the most to the decline. Debt mutual funds, often referred to as fixed-income ones, invest in safe instruments such as government securities and corporate bonds that offer fixed returns. They are the antithesis of equity funds, which invest in high-risk high-return stocks and shares. In July, there were net inflows into the debt funds by more than Rs 1,00,000 crore.
“Debt flows (in September) turned negative primarily due to quarter-end liquidity requirements. Festive season spending may also have contributed to the weak/negative flows in this segment,” said Anand Vardarajan, Chief Business Officer, Tata Asset Management. Hence, the surge in redemptions in debt funds was primarily driven by large institutional withdrawals from liquid and money-market categories.
Quarter-end liquidity was coupled with the advance tax-related outflows, and the latter become crucial as the halfway mark of the fiscal year ends in September, felt Nehal Meshram, senior analyst and manager (research), Morningstar Investment Research India. He explained that the liquid and money-market funds are often used by corporates and institutions for short-term cash management. Thus, these remain highly sensitive to seasonal liquidity cycles.
But such analysis does not explain the huge outflows in the months of May and June this year, before the tide turned around in July with major inflows. The categories that were the main beneficiaries in July included short-term ones such as money market funds, followed by liquidity and low duration funds. In fact, in early August, looking at July trends, experts said that this indicated a reversal in debt funds. They were confident that the downtrend had changed.
Looking at the July upturn, after two months of downsides, the experts explained that recent cuts in interest rates, and expectations of higher banking liquidity due to cut in cash reserve ratio were the primary drivers for the inflows. In the past two bi-monthly policy announcements, the Indian central bank kept rates unchanged, and explained that there was a lag effect related to the passage of the benefits of its earlier cuts to retail and corporate borrowers.
When it released the July figures, AMFI provided several technical reasons for the huge additions to debt funds. “The yield on the new 10-year benchmark 6.33 per cent government security 2035 was at 6.38 per cent on July 31 compared to 6.32 per cent on June 30. In the first half of the month (July), a fall in the US Treasury yields amid lower crude oil prices, and strong liquidity surplus in the Indian banking system supported bond prices. A cautious stance by investors amid uncertainty surrounding the US tariff policy, and strong demand at the RBI’s weekly debt auction also provided support,” it stated.
In July, money market funds witnessed the largest inflow of nearly Rs 45,000 crore, followed by liquid funds (Rs 40,000 crore), low duration funds (Rs 10,000 crore), and overnight funds (Rs 9,000 crore). There was a similar pattern, this time of outflows, in September. The liquid fund segment saw the sharpest withdrawals, with outflows of Rs 66,000 crore. Money market funds faced heavy redemptions, which amounted to Rs 18,000 crore. Overnight funds recorded more modest inflows of Rs 4,279 crore. “Some investors temporarily shifted funds into these short-term instruments amid broader market withdrawals,” said Meshram.
In September, the activity in medium and long duration funds was muted. “Medium-duration funds saw mild redemptions of Rs 157 crore, while medium-to-long duration funds posted a small inflow of Rs 103 crore, indicating limited but selective interest in building duration exposure ahead of a potential easing cycle,” says Meshram.
Ultra-short duration funds saw substantial outflows of Rs 13,606 crore, while low-duration funds registered net redemptions of Rs 1,253 crore, reflecting liquidity adjustments by institutional participants. Meanwhile, short-duration funds witnessed comparatively smaller outflows of Rs 2,173 crore, suggesting a more cautious stance in accrual-focused segments.
“These modest outflows (in specific categories) suggest that the investors remained broadly anchored to shorter-tenor accrual-oriented products, even as overall liquidity tightened toward quarter-end,” said Meshram. The dynamic bond category saw modest inflows of Rs 519 crore. “This reflects some tactical positioning by institutional investors anticipating eventual softening in yields.”
According to Karthick Jonagadla, investment manager on smallcase, and founder and CEO of Quantace Research, system liquidity flipped to deficit around September 22 on tax outflows, which typically normalises in early October. Overall, many experts felt that the September’s debt fund flows was a temporary trend, and reflected a liquidity-driven correction rather than a structural shift in sentiment. Institutional redemptions dominated, and retail participation in shorter-duration strategies remained steady.
“As liquidity conditions normalise, and investors adjust to a more extended policy-pause environment, allocations are likely to remain focused on high-quality accrual and short-duration strategies, with selective interest in duration products depending on future rate-cycle clarity,” points out Meshram. However, such explanations do not contextualise what happened in the months of May, June, and July. The first two witnessed outflows, followed by a huge inflow. In September, one saw another bout of huge withdrawals.
Once we keep the debt funds aside, and look at the overall mutual funds picture, there are different patterns that emerge. The industry added 40 lakh folios in September, with AUM inching up from Rs 75.18 lakh crore to Rs 75.38 lakh crore. The minor upward blip was due to the outgo from debt funds. Inflows via Systematic Investment Plans (SIPs) remained robust, which signalled the confidence among investors to stick to disciplined, long-term wealth creation.
There is another dynamic to mutual fund investment, which is not directly related to equities and debt funds. Investors have decided to switch a part of their portfolios to precious metals, given the surge in the prices of gold and silver, despite the recent corrections. “The September data underscores the increasing role of precious metals in long-term wealth diversification. For investors, it is a reminder that balancing traditional equity and debt hybrid strategies along with strategic asset allocation to metals can strengthen portfolios against economic uncertainties, while tapping into avenues for long term growth,” says Kartik Jain, MD & CEO, Shriram AMC.