What are the merits of debt fund systematic investment plans?

Let us look at a longer term perspective and see the funds that gave the best performance over a 10 year period.

Apr 07, 2020 12:04 IST India Infoline News Service

Debt Fund
You must be familiar with how systematic investment plans (SIPs) create wealth in the case of equities over the long run. That is because of a combination of rupee cost averaging and the power of compounding. But, what about debt funds! Can we adopt a systematic investment approach to debt funds too?

Lump sum investing versus SIP investing in debt funds
Let  us look at a longer term perspective and see the funds that gave the best  performance over a 10 year period.
Name of the Fund 10-Year Returns 5-Year Returns
IDFC G-Sec Fund (G) 9.684% 8.657%
SBI Magnum Gilt Fund (G) 9.587% 8.868%
UTI Gilt Fund (G) 9.208% 8.490%
Data Source: Morningstar

In all the above cases, the rates have been fairly consistent between 10-year and 5-year returns. Of course, we have only considered the growth options of regular plans here. Now, let us also look at the impact if we had opted for a 10-year SIP instead.
Name of the Fund 10-SIP IRR Returns
IDFC G-Sec Fund (G) 9.950%
SBI Magnum Gilt Fund (G) 10.130%
UTI Gilt Fund (G) 9.681%
Data Source: Morningstar

As can be seen in the above comparison of the two sets of government securities funds across lump sum investment and SIP investing, there is an advantage of 30 bps to 60 bps even in the top 3 funds if you had opted for an SIP approach. Why does this SIP advantage arise even in government securities funds? Remember, this is the annual yield differential; so over a 10-year period, this impact can be substantial on a large corpus.

Why SIPs work in the case of debt funds too?
Normally, debt funds (especially the government securities funds) are not that volatile. Yet, the SIPs appear to have an advantage over a longer period of time. Remember, 30-50 bps advantage is not small and can make a substantial impact over a 10 year period to bond fund returns.  Here is why SIPs make an impact on debt funds too.
  1. G-Sec funds are the most vulnerable to shifts in the repo rates by the RBI. If you see since early 2015, the repo rates are down by nearly 300 bps and this contributed substantially to returns on government bond funds. While it is impossible to time your entry and exit precisely, a SIP becomes an active approach in auto mode. The disciplined SIP approach tends to even out the interest rate impact over a period of time and works in favour of the investor.
  2. Bond markets have been volatile because there are factors other than interest rates that have a bearing on the bond markets. For example, the currency movements, IIP growth rate, the rate of inflation and even the FPI buying and selling in the debt markets have an impact on the bond prices. These are highly uncertain variables and cannot be predicted with any degree of certainty. The best solution is to adopt a SIP approach that will automatically smoothen out the jagged edges off the market.
  3. SIP gives greater flexibility of taking a more dynamic approach. For example, bond funds do very well in times of falling rates but underperform when rates are rising. A dynamic approach automatically reduces your SIP allocation to government bond funds when rates fall beyond a point and automatically increase allocation when rates rise above a point. This reduces downside risk and helps SIPs to perform better.
  4. With the best of analysts and economists in your roll, it is hard to estimate the future movement of interest rates and bond prices. Most of them can only get it approximately right. If you are taking a lump-sum approach to investing in bond funds, you still run the risk of what is popularly known as the economist bias. Quite often, these economic variables do not adhere to strict frameworks and that is where the risk arises. These risks can be best addressed through a SIP approach to debt funds.
  5. Finally, as we have seen in our illustration earlier, SIPs work in practice. The fact that they have actually given enhanced returns across 3 of the top performing funds is evidence that there is merit in doing SIPs in debt funds too.
One confusion that investors in debt funds often have is that debt fund investments are often lump-sum inflows that get invested. One way to resolve this puzzle is through the systematic withdrawal plan (SWP) approach. You invest the corpus in a liquid fund and swipe the money out in 6-12 instalments into a G-Sec fund. Your idle funds earn better returns and the systematic approach to investing in government bond funds adds to your overall returns.

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