Debt funds are investment vehicles that invest in fixed income securities, such as bonds, debentures, and other debt instruments. They are designed to provide investors with a source of steady, income-generating investments. Debt funds can be further classified based on the type of securities they invest in, such as government bonds, corporate bonds, or high-yield bonds.
Reasons to invest in a debt fund
The existence of aforementioned risks does not mean an investor must stay away from debt funds. Debt Funds can be considered for investments for the following reasons:
- Stability: Debt instruments provide stability to one’s portfolio. The investor knows that he/she can always fall back on this asset class. If you have invested in Gilt Funds, you are assured that you will get back your money and some decent returns, provided you have held it for a reasonably long period of time.
- Higher Tax adjusted returns: If one holds a Debt fund for a period of more than 3 years, one can benefit from indexation and a lower tax rate, which means, post tax returns on a debt fund are higher than if you invest in a Fixed Deposit or bond for a similar period.
- Stable returns: Overnight or liquid funds can be considered if you are looking to park your money for a short period of time for steady returns without hits. The credit risk and volatility in these funds is minimal.
- High risk: Investors with an appetite for risk can consider funds/instruments that are high on credit risk. These can result in high yield if there is no default. However, this requires a greater understanding and analysis of the risks involved.
Tips for managing your debt fund
- Investment in Debt Funds should be as per your asset allocation.
- Clearly identify time horizon of investment and choose the funds accordingly.
- Unless you have an appetite for risk, stick to GILT Funds.
- If investing for longer term, Constant Maturity funds can significantly reduce the interest rate risk
- If the investment horizon is less than 3 years, one is better off with liquid funds or overnight funds, rather than dabble with GILTs and other medium/ long duration funds
- Diversify across fund houses. Limit the exposure between 10% to 25% even with high-quality funds.
- Keep track of your fund’s AUM size, as AUM of short and liquid funds, is often volatile because of the movements of corporate treasury money.
- Understand credit risk categories are riskier than equity ones.
- Take the help of a SEBI Registered Investment Advisor (RIA) to help you in making the right investment choice.Shift your money to bank deposits and other investments that provide liquidity and protect capital. Do not chase the extra 50 basis points of return, as it is not worth the risk. Even debt funds do not provide 100% capital preservation.
There are several factors to consider when selecting a debt fund, including the following:
- Investment objective: It’s important to understand the fund’s investment objective and how it aligns with your own investment goals. For example, do you want a fund that focuses on income generation or one that aims to preserve capital?
- Risk profile: Debt funds come with varying levels of risk. It’s important to consider the fund’s risk profile and how it aligns with your own risk tolerance.
- Credit quality: Debt funds invest in securities issued by various entities, such as governments, corporations, and other organizations. It’s important to consider the credit quality of the securities held by the fund, as this can affect the fund’s risk profile and potential returns.
- Expense ratio: Debt funds charge fees to cover the cost of managing the fund. It’s important to consider the expense ratio of the fund and how it compares to similar funds.
- Performance history: It’s a good idea to review the fund’s past performance to get an idea of how it has performed in different market conditions. However, it’s important to note that past performance is not necessarily indicative of future results.
- Diversification: Debt funds may invest in a variety of different securities, such as government bonds, corporate bonds, and high-yield bonds. It’s important to consider the level of diversification within the fund and how it aligns with your own investment goals.
It’s generally a good idea to research and compare several different debt funds before making a decision, and to consult with a financial advisor if you have any questions or concerns.
