Things to keep in mind when selecting a debt fund

With numerous choices available, selecting the right debt fund requires careful consideration of various factors to align with individual financial goals, risk appetite, and market conditions.

Investors should assess their investment objectives and time horizons before investing in debt funds. Whether the goal is capital preservation, income generation, or wealth accumulation, clarity on investment objectives lays the foundation for selecting the appropriate debt fund category. Besides these, you should also be privy to the two primary kinds of risks involved in mutual fund investing:

Interest rate risk

Debt Funds allocate capital to debt instruments such as bonds. Their valuations fluctuate in response to shifts in interest rates or market expectations regarding interest rate movements. When interest rates decline or are anticipated to decrease, bond prices rise due to heightened demand, exemplifying an inverse relationship between interest rates and bond prices.

Conversely, in a scenario of rising interest rates, bond prices depreciate as demand diminishes for bonds with comparatively lower interest yields. This phenomenon, wherein bond prices fluctuate due to changes in interest rates, encapsulates the concept of interest rate risk.

Credit risk

You might be familiar with personal credit scores, such as the CIBIL score, which evaluate your past loan repayment history to determine your creditworthiness. Similarly, companies are also subjected to ratings by credit rating agencies, like CRISIL and ICRA, which assess their ability to repay debt based on financial performance and past records. These agencies assign ratings reflecting the company's debt repayment capability, with AAA representing the highest certainty of repayment and, consequently, the lowest credit risk, followed by AA indicating slightly higher risk, and so forth, until D, which denotes default risk. Opting for debt funds that lend to highly rated corporations is an effective strategy to mitigate this risk.

Other factors

In addition to these risks, another crucial aspect of selecting debt funds is evaluating the fund manager's track record and expertise. Fund managers play a pivotal role in navigating the intricacies of the bond market, optimizing portfolio returns, and managing risks effectively. It is also crucial to evaluate the fund manager’s tenure, experience, and performance metrics when selecting debt funds.

Of all the types of debt funds, overnight and liquid funds are the safest. They have minimal credit or interest risks. Short-term funds, corporate bond funds, and Banking and PSU funds have high-credit-quality bonds in their portfolios and carry very low interest and credit risks. Dynamic Bond Funds and Credit Risk Funds have the potential to deliver higher returns but also have higher risks.

When evaluating debt funds, investors should also pay attention to quantitative metrics such as expense ratio, yield to maturity (YTM), and historical performance. A lower expense ratio enhances investors' net returns over the long term. Similarly, a higher YTM coupled with consistent historical performance indicates the fund's ability to generate competitive returns while managing risks effectively. A larger AUM (assets under management) for a debt fund shows that more people are interested in it and it's doing well.

An Investor education and Awareness initiative of Aditya Birla Sun Life Mutual Fund

All investors have to go through a one-time KYC (Know Your Customer) process. Investors to invest only with SEBI registered Mutual Funds. For further information on KYC, list of SEBI registered Mutual Funds and redressal of complaints including details about SEBI SCORES portal, visit link : https://mutualfund.adityabirlacapital.com/Investor-Education/education/kyc-and-redressal for further details.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

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