Why is SIP in Debt Funds Right For Fixed Income| Mirae Asset (2024)

Different asset classes, e.g. fixed income, equity, gold etc. have different risk return characteristics. Equity is the most volatile asset class and has the potential of giving higher returns in the long term. Gold is less volatile than equity and can act as a hedge against inflation. However, Gold is more volatile than fixed income. Fixed income aims to reduce portfolio risks, provide stability and generate portfolio income.

Different asset classes outperform each other in different economic cycles. Equity and gold are usually counter-cyclical. Different asset classes also outperform each other in different economic cycles. Fixed income may outperform equity in bear markets, while equity may outperform fixed income in bull markets. Similarly gold and equity cycles are different. While equity outperforms fixed income in bull markets, fixed income outperforms in bear market.

The chart below shows the growth of Rs 10,000 investment in equity (represented by Nifty 50 TRI), fixed income (represented by Nifty 10 year Benchmark G-Sec Index) and gold over the last 10 years ending 31st December 2020. You can see that fixed income outperformed both equity and gold over fairly long periods. Diversifying across asset classes reduces volatility and brings stability to your portfolio.

SIPs in debt funds can generate relatively good returns over long investment tenures. The chart below shows the growth of Rs 10,000 monthly SIP in Nifty 10 year G-Sec Index over the last 10 years ending 31st December 2020. The annualised SIP return (XIRR) over this period was 7.7%.

Though SIP in debt funds may be a relatively new concept for many investors, most investors are familiar with another form of systematic investment in fixed income – bank recurring deposit (RD). The chart below shows how monthly SIP in Nifty 10 year G-Sec Index outperformed same monthly investment through recurring deposits (RD). The XIRR of monthly recurring deposits over the last 10 years was 7% compared to 7.7% XIRR for Nifty 10 year G-Sec Index.

SIPs take advantage of volatility through the Rupee Cost Averaging of purchase price. Investor usually associate volatility with equity investments but fixed income can also be volatile due to changes in interest rate (yields) and credit spreads. See the chart below which shows change in yields of 10 year Government Bond (10 year G-Sec), 10 year AAA rated corporate bond and 10 year AA rated corporate bond over the last 5 years (ending 31st December 2020). Longer the duration of a debt fund, higher is the price volatility of the fund due to change in bond yields.

This is another reason why you should invest in debt funds through SIPs, we think that this deserves special mention because this is significant advantage which SIPs in debt funds enjoy over traditional investment options like bank RD. Debt funds are more tax efficient than bank RDs. While bank RD interest is taxed during the tenure of your investment at the income tax rate of the investor, debt fund returns for growth options are taxed only on redemption and long term investors (3 years plus tenures) can avail of indexation benefits.

Long term capital gains in debt funds are taxed at 20% after allowing for indexation benefits and therefore, offer significant tax benefits for investors in the higher tax brackets. Debt fund SIP investors however, should note that you can avail long term capital gains tax benefits only for SIP instalments that have completed 3 years from the date of instalment.

All debt funds are not suitable for SIPs. You need to have long investment tenures because SIP returns are highest in the long term due to the power of compounding. Debt funds which have higher volatility and need long investment horizons should be considered for SIPs. The table below can help you decide, which category of debt funds you can consider for investing through the SIP route. You should always consult with your financial advisor to help you select the right scheme according to your needs.