After the financial crisis, Prakash has been following the asset allocation model and portfolio rebalancing as tools to ensure that he is invested as per his pre-defined asset allocation percentage. The recent spurt in equity has skewed the asset allocation in favour of equity. His advisor, Ravi, has now re-jigged his portfolio according to the pre-defined asset allocation score. Ravi has also suggested booking of partial profits and investing them in debt funds.
Prakash considered bank fixed deposits as the safest form of debt investment. However, he has now been suggested to invest in debt mutual funds, which bring in both liquidity and tax efficiency. There is now a plethora of debt funds in the mutual fund space. Let?s look at a few of them and understand the suitable debt fund options:
Debt funds are mutual funds which invest in a variety of debt securities like commercial papers (CPs), certificate of deposits (CDs), government securities or gilts, treasury bills, bonds and money market securities. The most common classes of debt funds are:
Fixed maturity plans: As the name suggests, the investment is for a fixed period, say 100 days, 370 days or even 1,000 days. FMPs invest in instruments that mature at the same time that their schemes come to an end. So, a 100-day FMP will invest in instruments that mature within this period. This insulates the schemes from volatility in interest rates.
In FMPs, returns are not guaranteed. However, usually indicative returns are disclosed. The major advantage of an FMP investment is that it is tax efficient in two ways ? double indexation benefits and lower tax rate
In case an investor has a demat account and there is a need for liquidity, FMPs can also be traded. Besides FMPs, there are also interval funds, which are also valid for a fixed period, say, monthly, quarterly or annually. In this instance, the funds are open for redemption or purchase only during a specific day of the month or the quarter.
Liquid funds or money market funds: Money market funds or liquid funds invest in money market securities and debt securities that mature in 91 days. This is an ideal instrument to park funds for short-term requirements, before allocating the funds for long-term investment needs. A major benefit of this is a higher interest rate than the savings bank rate, a zero exit load and easy liquidity.
Ultra short-term funds: Ultra short-term funds, earlier known as liquid-plus funds, are slightly riskier compared to liquid funds and tend to give slightly higher returns. The funds invest in debt securities maturing in over of one year. It suits investors who want to park their money for a few months.
Short-term funds: Short-term funds invest in debt securities that mature in the next 15 -18 months. They invest mostly in AAA or AA+ rated debt securities and interest rate hikes mildly impact the returns. Short-term funds are best suited for investors with an investment horizon of 1 – 2 years.
G-secs: G-secs or government securities or gilt funds invest in debt securities issued by RBI on behalf of the government of India or the state governments. G-secs have no risk of default, as they have a sovereign guarantee but are, however, prone to interest rate movements. G-secs come with a wide range of maturity periods, from a few days to 10, 20 and 30 years. So, many gilt funds have short-term and long-term plans. Ideally, they are suited for an investment horizon in line with the asset allocation strategy.
Monthly income plans: Monthly income plans or MIPs are hybrid investment funds and are being aggressively sold today. They invest a minor portion (5-25%) in equities and the rest in debt securities. MIPs aim to provide regular and periodic incomes, either monthly, quarterly, half-yearly or yearly. The income is guaranteed, which is not the case in mutual fund MIPs. Only the surplus distributable income is available for distribution. They are more suitable for investors looking for regular income rather than capital appreciation.
* The writer is founder of WealthWays Private Wealth Management