Best Debt funds
A debt fund is meant for those who want steady returns but do not want the risk involved in equity investments. Debt mutual funds invest in fixed income instruments that include government securities, commercial paper, treasury bills, corporate bonds, money market instruments and other debt of varying maturities. There are many offerings in the market, so here are some pointers on how to find the best debt funds.
How to find the best debt funds
Risk appetite: The best debt mutual funds for you are those that meet your risk appetite. Generally, funds that invest in government paper like bonds carry the least amount of risk. For instance, a gilt fund will invest only in government paper so there is very little risk of default.
Liquidity: Another factor to consider is liquidity, the length of time you want to invest your money in. For example, if you want to invest your money for a very short period of time, the best debt funds for you would be liquid funds, which can be redeemed quickly, even within a day. If you are prepared to stay invested for a longer time, the best debt funds for you would be income funds, which invest in fixed income instruments of a longer tenure.
Asset allocation: It’s important to look at the fund’s asset allocation – what proportion it invests in corporate paper and what percentage in government bonds. Generally corporate bonds and debentures offer a higher rate of return than government securities, but also involve higher risk. If you are a cautious investor, the best debt funds for you would be those that have a major portion of assets under management in government bonds. However, you must remember that investment in government bonds carry interest rate risk and in a rising interest rate scenario, yields will drop along with NAVs.
Size of fund: The best debt mutual funds have a large corpus of assets under management. This is because investing in debt involves some transaction costs, and large funds are able to enjoy the benefit of economies of scale since they invest in bulk. They will also be able to negotiate better interest rates from borrowers. This helps reduce the expense ratio. In smaller funds, there’s always the danger of overexposure to one or few borrowers, which won’t be the case with larger funds. Plus, a large fund will be able to handle redemption pressures better
Expense ratio: You have to look at expense ratios carefully. Since returns from a debt mutual fund are on the lower side, a high expense ratio could make a significant difference. The best debt funds for you would be those that have a low expense ratio.
Credit rating: When you look at a debt mutual fund’s portfolio, you will also be able to see the rating of every corporate debt. The best debt funds in India invest in instruments that have a high credit rating. Of course, you must also remember that instruments with lower ratings will have to offer a higher rate of interest, so may earn more interest. But the risks too are commensurately higher.
Compare funds: Many web sites compile a list of the best debt mutual funds in India according to their performance. You can download the AngelBee app for mutual fund investment to find the best debt funds in India.
Liquid debt funds are suitable for investors who want to park funds for short periods. Investments could be as short as a day! Liquid funds invest in fixed income instruments with very short maturities of up to 91 days, like treasury bills, certificates of deposit and commercial paper. The focus of these funds is basically capital protection, rather than ensuring high returns. So fund managers tend to err on the side of caution and invest only in those instruments that have a high credit rating. Mutual fund companies try to keep costs to a minimum so that investors don’t have to pay high expense ratios and reduce their returns.
Ultra short term funds
Ultra short term debt funds are similar to liquid funds. These funds invest in fixed income instruments of a very short duration with a certain portion in longer-term securities. Generally, the instruments do not have a residual maturity of over a year. Ultra short term funds are aimed at investors who want to park money between one and six months.
Overnight debt funds are a variation of liquid fund; you can call it ultra-liquid funds. These invest in debt and money market instruments of overnight maturity.
Gilt funds invest in central and state government securities that have a medium and long term tenure. These debt funds are aimed at investors with a longer-term perspective. Since the securities gilt debt funds invest in are guaranteed by the government, there is no risk of default. So to that extent they are free from risk. However, gilt funds are not immune from interest rate risk. When interest rates rise, yields go down as do the net asset values (NAVs) of gilt funds. Higher the maturity profile of these instruments, higher the risk.
Corporate bond fund
A corporate bond debt fund, as the name suggests, invests in the debt of companies that want to raise money to meet their working capital requirements or for capital expansion. This kind of debt is also known as non-convertible debentures. Corporate bond funds are suitable for investors who want a higher rate of return than, say, gilt funds. Returns on these debt funds depend on the kind of paper they invest in. For instance, a fund that invests in corporate debt with low ratings could offer higher returns, but will take on higher risks. The risks are mainly in the form of defaults, which will be on the lower side if the fund invests in debt with high credit ratings. These debt funds are suitable for investors with a longer time horizon.
Income funds are preferred by investors who do not want to take much risk and enjoy a stable income over the longer term. Income debt funds invest in a mix of government securities and corporate paper with maturities of around five years. Of course, like gilt funds, these funds too are subject to interest rate risk.
Money market funds
Money market debt funds invest in fixed income instruments of short maturities and minimal credit risk. They invest in commercial paper, commercial bills, certificates of deposit and treasury bills, with maturity periods of up to a year.
Credit risk funds
Credit risk debt funds are meant for investors who are willing to take on more risk in the hope of making higher returns. Credit risk funds invest in paper that have a lower credit rating. Companies issuing such paper have to offer higher interest rates to attract investors, so returns are higher here. These funds were earlier called credit opportunities funds, but Sebi has now asked them to be renamed credit risk funds. Credit risk funds generally hold the securities till maturity. The problem with these funds is the lack of liquidity — if they face redemption pressure, they will have to sell securities at high yields, thus lowering NAVs. And there is also the risk of default.
Banking and PSU funds
Banking and PSU funds put most of their assets under management in the debt instruments of banks, public sector undertakings, and public financial institutions. These include certificates of deposits (CDs), commercial paper (CP) and PSU bonds with medium term maturities. Banking and PSU debt funds involve lower levels of risk and are suitable for investors who would, for instance, put their money in bank fixed deposits. There are indexation benefits, so you may have to pay less tax if you hold these funds for over three years.
Balanced funds invest in multiple asset classes to meet the need for varying investment objectives and risk appetites. Balanced debt funds may invest in a mix of debt and equity. These are preferred by conservative investors who want to enjoy the steady returns and low risk that a debt fund involves, combined with the high-return-high-risk profile of an equity fund. Generally, balanced funds in India invest 60 per cent of their corpus in debt and 40 per cent in equity. A conservative fund may invest less in equity and more in debt.
The right time to start investing in debt funds is now. Like equity funds, debt funds too must form part of your portfolio to reduce risk. There are many kinds of debt funds and you can choose the best debt funds to invest in depending on your risk appetite, investment goals and liquidity needs.
If you are a conservative investor, you can start investing in debt funds that involve less risk, like gilt funds. However you must remember one thing: debt funds too are not free from risk. It comes mainly from changes in interest rates. If interest rates go up, yields of debt funds will drop along with your NAV. If they fall, yields will rise, and you will see an increase in NAV. But these are small risks, and having a debt fund in your portfolio will pay off in the long run.
The AngelBee mutual fund investment app will help you choose the best debt fund to invest in and maximise your returns.