Debt Funds - The Secure Mutual Funds

Money forms the basis of all economic activities. It is both means and end behind all economic activities. Hence, different entities raise money in different forms regularly for the smooth conduct of such economic activities. Even governments raise money from time to time for their monetary needs in the form of G-Sec or gilts. Similarly RBI issues T-bills for the short term monetary needs of the government. Such instruments being backed by Government are highly credit worthy. Comparatively debt instruments issued by private bodies like corporate have lower credit worthiness.  

Mutual funds that invest in these fixed income securities like Glit or G-Sec , corporate bonds, treasury bills, debentures and company fixed deposits are included in debt funds. Debt funds are comparably less volatile than equity based funds hence suggested for those investors who want steady income flow.

Major parameters to analyse a Debt Fund are –

1  Average Yield – It is the weighted average yield of all the debt instruments that constitute a debt fund.

2  Average Maturity – It is the weighted average maturity period of the debt fund constituents.

3 Modified Duration – It is the multiple by which debt fund returns are affected by the increase or decrease in the market interest rates. Every time RBi increases or decreases different bank rates like Repo Rate, Reverse Repo Rate, SLR etc., this parameters comes into play.  Debt Fund returns have inverse relationship with market interest rates. So Debt funds appreciate in a falling interest rate scenario and depreciate in a rising interest rate scenario.  Higher is the maturity period of the debt instrument, higher is its Modified Duration.

4  Credit Ratings – All debt papers are provided ratings by independent third parties like CRISIL etc based on credit worthiness of the issuing institute.

Sources of Risk in Debt Funds –

Risk is an integral part of even Debt Funds. Risk arises in Debt funds from two potential phenomenons –

1. Credit Default – the risk of the debtor not honouring his commitment to payback forms the credit default risk. It can be minimised by ascribing to debt instruments of higher credit ratings

2.   Interest Rate Volatility – Debt funds having higher value of Modified Duration are prone to vagaries of interest rate ups and downs. It is always suggestible to buy Debt funds with higher modified duration in interest rate falling scenario and vice versa to make best use of both scenarios.  But it is always very tricky to predict direction of interest rates as they are a function of lot many parameters like inflation, growth rate, liquidity and as in Indian context even Monsoon.

Types of Debt Funds

1.  Gilt Funds invest only in treasury bills and government securities which practically do not have any credit risk. But G-Secs generally are of very high durations; hence have very high modified duration.

2.  Diversified Debt Funds invest in a mix of government and non-government debt securities.

3. Fixed Maturity Plans are the close-ended schemes in which fund manager has an ongoing role for deciding the investment options .The maturity of scheme is closely aligned to investment portfolio. These plans also help investor to compare the returns of schemes with other plans in advance.

4. Junk Bonds Schemes are high yield bond schemes which invest in companies having poor credit quality so the losses arising out of few defaulting companies can give attractive returns.

5.  Floating Rate funds invests in those financial instruments in which the interest rate floats or varies in line with the underlining level of fixed rate coupons. The best time to invest in these funds is when the interest rates are rising so there will be low degree of sensitivity.

6.  Liquid Schemes are debt schemes that invest for very short period of time within 61 days and give high returns at lower risks due to its short duration. They are the least volatile of all debt funds as they have the shortest maturity papers.

A balanced portfolio always has a component of Debt Funds to provide it stability. The relative allocation of this fund class depends on the overall profile of the investor.

Click here  to understand how Debt Funds score over assured returns of Fixed Deposits. Visit our Facebook Page to keep yourself updated about everything and anything that concerns your investments and finances.