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Why You Shouldn't Avoid Debt Mutual Funds? - ABSLMF Blog

Why shouldn't you avoid debt mutual funds completely?

Dec 02, 2019
4 mins | Views 7786

The discussions about mutual fund investing tend to revolve around equity funds, as retail investors generally see mutual funds as a proxy to investing in the equity markets. While the data indicates that around 48% of assets in the mutual fund industry come from debt funds (Source – Association of Mutual Funds in India, AMFI, data as on 30th September 2019), most of it comes from the institutional and corporate clients only. This may be attributed to their utility towards treasury management, and hence, companies invest their surplus funds in debt funds in pursuit of reasonable returns and lower portfolio volatility. This is reflected in the AMFI data as at 30th September 2019 as well, which indicates that only around 8% of the total investor folios across the mutual fund industry contribute to roughly half of the Assets Under Management (AUM) of Rs. 11.65 lakh crores in debt mutual funds.

The reason why debt funds are not much popular with the retail investors might be the fact that investing in debt products is not as exciting as investing in equity. Since most of the debt securities carry fixed income, the debt portfolio tends to generate reasonable returns. However, over the last year, debt markets have remained in focus, due to regular policy actions by the Monetary Policy Committee of Reserve Bank of India and also due to few credit default events. The negativity around corporate debt papers has also resulted in elevated yields presently, as the credit spreads have stayed wide across the credit rating matrix. As such, this can be a good time to invest at prevailing higher yields and benefit while providing stability to the portfolio.

Further, investing across the asset classes, i.e. equity and debt helps the investors to maintain a diversified portfolio to mitigate the investment risk. This is because similar macroeconomic developments may cause different asset classes to react differently. For example, the recent tax rate cut was seen as a great boost to economy and the equity markets echoed that positive sentiment. However, the debt yields went higher on expectations of higher fiscal deficit and higher borrowings by the Govt. Similarly, different asset classes have their respective economic cycles. Accordingly, the investors must not overlook debt funds while deciding upon the optimal asset allocation for their investment portfolio. The recent performance by the debt funds category may also act as another incentive for you towards investing in debt funds. While most of the equity funds categories have stayed volatile over the last one year, long-duration debt funds have generated returns of around 18% during the same period (Data source – ValueResearchOnline, as on 15th October 2019).

Here are different sub-categories of debt funds which the investors can consider investing in:

  • Overnight and Liquid Funds – Such funds invest in debt and money market securities with maturity of 1 day and up to 91 days, respectively. While liquid funds may provide faster processing for redemption, both liquid and overnight funds stay significantly insulated from the interest rate risk due to the short portfolio duration.

  • Duration funds – Such funds seek to invest in the fixed income securities of varying durations. In simpler words, duration refers to the residual time until the maturity of the debt security. Examples of duration funds are ultra short term duration fund, dynamic bond, low duration fund, etc. The interest rate sensitivity is directly proportional to the duration of the fund. As such, higher duration funds (long term debt funds) could be more beneficial during the decreasing interest rate scenario, and similarly, short term debt funds may be more relevant in increasing interest rate scenario.

  • Gilt funds - Such funds invest in Government Securities (G-Sec). On account of G-Secs being the sovereign securities, the credit risk may be considered as minimal, but the interest rate risk may still be there depending upon the duration of the portfolio. Since the duration of G-Secs tends to be higher, the interest rate sensitivity would also be higher in such funds.

  • Credit Risk Funds – Such funds invest in securities issued by companies with different credit ratings and hence, capitalise on different credit spreads across the credit rating and appreciation in the portfolio valuation due to potential rating upgrades.

Accordingly, the investors can allocate a reasonable proportion of their portfolio into debt fund investments as well, considering the availability of wide range of debt funds suiting different risk profiles.

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

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