Why did Liquid and Debt funds fall and why they will recover soon.

Many debt fund investors have panicked in the past few days since the debt funds have shown negative returns of few basis points for the past 1 - 3 days. Why is this happening and what should investors do?

Why did the NAV fluctuate?

Just like how Equity Mutual Funds invest in stocks of different companies, Debt Mutual Funds invest in Bonds and Certificates of Deposit (similar to Fixed Deposits). Liquid Funds especially only invest in Bonds and CDs of PSU companies and highly rated private companies.  

Many institutions and businesses which have purchased such bonds and required the funds for their day to day business activities have sold the bonds in the markets. When such a sell-off happens, the price of the bonds decrease and hence the NAV has fallen anywhere between 0.01 and 0.15% in the past few days.

There is a common misconception among investors that there has been a credit default which has caused a fall. There has been no credit default in any of the Liquid/Ultra Short Term funds.

What is going to happen now?

In order to buy the bonds that are being sold by the institutions, RBI has intervened and purchased Rs. 10,000 crores of bonds in the markets today. This means that all the funds that had the drop would see a good increase in the NAV thereby compensating for the fluctuation.

What should investors do?

Absolutely nothing. The extent of fluctuations due to the selling was less than 0.15% on average and after the immediate intervention of RBI the NAVs have recovered again. This happens once in a few years when the companies sell their bonds for cash, and is usually followed by RBI intervening and purchasing the bonds to restore the NAV.

No need to panic. Happy investing!