Most investors think that Debt Mutual Funds are a safe bet. It is a myth. Debt funds may not be as risky as equity funds because they invest in risk free assets like Government Bonds, T-Bills, G-Secs, FDs, etc. But they can also erode your
capital if they make a wrong credit or interest rate call.
How does a debt fund lose money? It can lose value if interest rates go up. How? As interest rates go up, the latest bond offerings will give higher interest whereas your mutual fund may have invested at old interest rates which were lower, as a result, your mutual fund earns less and your NAV of units are lesser.
If an instrument held by the mutual fund, suffers a sudden loss, it can also lead to lower NAV. For example, if your Mutual Fund is holding bonds issued by Suzlon and suddenly the bond rating of Suzlon due to its poor internal financial health is downgraded from AAA to BBB status, markets in those bonds will mark down its value and suddenly there will be a decline in the market value of that security. This leads to lowering NAVs of debt funds.
A recent example has been the fall in Amtek Auto share prices. The company’s bonds also took a hit.. Thus, all MFs which had invested in those bonds also suffered losses and the NAVs dropped by almost 15%.
Therefore, all those investors who look at debt funds, need to think twice. They may also not be as safe and have similar risks as equity funds, albeit a bit less.