Reasons To Invest In Debt Mutual Fund

Posted On Monday, Sep 21, 2015

Investors in India have traditionally been risk averse and tend to invest in bank deposits and fixed deposits of NBFCs (Non-Banking Financial Companies). The tendency of Indians is more towards capital preservation and their risk appetite seems to be low especially if we exclude the top 15 cities.

Investors who are risk averse or want to keep a certain portion of their assets in fixed income bearing securities can invest in debt mutual funds. Debt funds, amongst themselves have different risk profiles, which allows investors to choose funds based on their risk appetite and return expectations in these funds.

Investors in debt mutual funds are exposed to inherent risks such as interest rate risk, credit risk, illiquidity risk and market risk etc. Interest rate risks refers to the risk when prices of the securities purchased move up or down due to changes in macro-economic conditions like higher inflation, higher government borrowings, adverse effect on rupee due to higher current account deficit and other global market developments. Credit risk refers to the risk, when the securities which the fund is holding get downgraded or when there is a possibility of the issuer of the security defaulting in payment of principal or interest. Market risk refers to the risk when the underlying securities cannot be liquidated at the price at which it is valued, due to markets not being deep enough to absorb the sale of the securities.

The debt funds offered by mutual funds can be broadly classified into three categories based on the varying level of interest rate risk, credit risk and market risk. The funds are also classified on the basis of the holding period restrictions. Normally, funds have exit loads for different types of risk which is run by the fund house. Let’s look at the popular categories of debt funds.

Investors who want to keep money for very short periods of time but want a higher interest than offered on savings account may invest in Liquid Funds offered by mutual funds. These liquid funds invest in Money Market Instruments which mature within 91 days. The underlying instruments have the highest short term rating which indicates the companies’ ability is very strong for payment of interest and principal. This reduces the probability of credit risk of the portfolio. The portfolio of the fund has an average maturity of around 30 to 45 days, which reduces the interest rate risk too; longer the maturity of the portfolio, higher is the interest rate risk. The returns of the individual securities in the portfolio are generally slightly above the prevailing call money rates (Call money is a Money Market arrangement for overnight transactions between banks, and primary dealers). Investors in these funds may be getting a return close to the call money rates.

A variation of these funds is the Short Term Bond Funds, which has a portfolio maturity of one to two years. Bulks of the portfolio of these funds are generally invested in one to two year papers. The returns of these funds come from interest accruals. Investors in these funds are expected to stay for 3 to 6 months period. These funds do have some amount of credit risks, the risk of downgrades due to expected change in companies’ profile as these investments are made for more than one year. Therefore, these funds are suitable for investors who want less interest rate volatility.

Investors can also invest in Income Funds, Dynamic Bond Funds, or Gilt Funds. Income funds normally create a portfolio consisting of corporate bonds and government securities. These funds have an average maturity of 4 to 8 years, which exposes the investors to higher interest rate risks. The funds also have credit risk, the chance of downgrade in the corporate securities held in these funds. The funds also have some market risk owing to corporate securities held in the portfolio; these papers are relatively illiquid compared with government securities.

Investors can also invest in Gilt funds. Gilt funds invest in government securities which have relatively less credit risk. However, these funds have high interest rate risk as they invest in longer maturity papers. The market risks of these papers are low as they are very liquid instruments.

Thus, to summarize, debt funds come in all sorts of varieties. Investors can work with a financial advisor to choose the type matching their risk appetite, goals and return expectations. However fixed income products should ideally be part of every investor’s portfolio; this will help to achieve balance with equities.

Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Please visit – www.QuantumMF.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

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