Invest in Debt Mutual Fund: Mutual funds not only provide growth through equity funds, but they also bring balance and stability through debt funds.
Invest in Debt Mutual Fund
Mutual funds not only give growth through equity funds, but they also bring balance and stability through debt funds. Not only this, debt funds are also safe and liquid. Debt funds can also provide higher returns than other traditional investment options like bank FDs. In this article, we are going to talk on three main points. These three things are… .. The role of debt funds in your portfolio, choosing the right debt fund according to your financial goals, investing in debt funds.
1. Role of debt funds in your portfolio
Debt funds help in meeting the short and medium-term goals of the investor with moderate risk and regular income. For this, corporate invests in various fixed income instruments such as debt securities (bonds and debentures) and money market instruments (commercial paper, bank deposit certificates). The fund invests in multiple borrowers, reducing the risk of over-exposure in a single company. Debt funds are also suitable for investors seeking regular income, as they are less volatile. One can choose a debt fund based on its specific time frame, liquidity requirements and risk appetite.
2. Choose the right debt fund
The investor should first understand the major risks of each fund. Let’s know what these are.
(A) Liquidity Risk
Liquidity risk is the risk of returns while liquidating securities to generate cash. Liquidity depends on the complexity of the risk instrument, its rating and duration of maturity.
(B) Credit Risk
The risk of default on maturity or non-payment of interest or principal is called credit risk.
(C) Duration Risk
The risk of change in the value of a bond when interest rates change in the economy is called Duration Risk. In general, this risk increases with the duration of the instrument.
Most debt funds have a fraction of all these risks. However, usually, one of these risks dominates, depending on the nature of the product. Let us know which product dominates which risk under what circumstances.
A few days to a few months
Situation: Emergency Fund, Surplus Money, Savings Account Options, Household Spending
Fund Type: Overnight or Liquid
Dominant risk: Liquidity risk
A few months to a year
Situation: House Maintenance, New Gadgets, Advance Tax
Fund Type: Ultra Short Duration Fund, Short Duration, Low Duration, Money Market
Dominant risk: Liquidity risk
1 year to 3 years
Situation: Car purchase, down payment for the home
Fund Type: Floaters, Banking and PSUs, FMPs, medium-term, medium to long term, corporate bonds
Dominant risk: Medium Level of Duration Risk
3 years to 5 years
Situation: To supplement returns from other products
Fund Type: Credit risk
Dominant risk: Credit risk
Over 5 years
Situation: To achieve long term goals like children’s education and retirement
Fund Type: Gilt and long span
Dominant risk: Duration risk
Debt funds generate returns for an investor using either credit or period to generate returns.
(K) The gradual strategy (in which credit risk dominates) depends on generating a steady interest income stream while keeping interest rate risk moderate and managing credit risk. Most credit risk funds buy and hold securities until maturity. The period of instruments in these funds is usually between one to three years. These funds also maintain some liquid holdings and cash to meet any contingency requirement. However, it is a bit difficult without sacrificing some returns on selling credit securities on short notice.
(B) On the other hand, funds that follow a duration strategy try to benefit from changes in the bond price in response to the movement of interest rates. Bond prices and interest rates move in the opposite direction. So when interest rates fall, the price of existing bonds rises, because these bonds need to be re-adjusted to a new level of the interest rate. As the new bonds carry less interest, the existing bonds become more attractive. In this way, prices rise until the yields match the new bonds. A duration fund will try to increase capital from the bonds it holds. The fund manages the risk by investing in a portfolio of carefully selected long-term debt instruments.
3. How to invest in debt funds?
Investing in debt funds is quite easy. Most medium and large-sized fund houses offer most of the debt products listed above. Investors can invest in a specific product according to their requirement after getting the track-record of the asset management company and specific schemes. Here the investor should compare the performance of the fund not only with the products of its category but also on the basis of the respective benchmark and the objectives of the fund.
(Author: Kumaresh Ramakrishnan, CIO-Fixed Income, PGIM Mutual Fund)
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