Not confident about FD? Here’s a better alternative

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Updated: September 9, 2016 7:29:07 AM

As banks reduce their deposits rate, retail investors are gradually putting money in debt fund of mutual funds.

To minimise credit risk, analyse the portfolio of the fund which is disclosed by AMCs every month. Invest in those funds that rank high on both criteria – consistency of return and portfolio with good credit. (Source: reuters)To minimise credit risk, analyse the portfolio of the fund which is disclosed by AMCs every month. Invest in those funds that rank high on both criteria – consistency of return and portfolio with good credit. (Source: Reuters)

As banks reduce their deposits rate, retail investors are gradually putting money in debt fund of mutual funds. Buoyant inflows in income, equity and balanced funds lifted the assets under management (AUM) to a record Rs 15.63 lakh crore in August. Debt funds reported inflows for the fifth consecutive month and AUM crossed the Rs 7 lakh crore mark, according to data from Association of Mutual Funds in India.

Better returns than bank FDs

Debt funds can give better returns than bank fixed deposits and are as liquid as any bank fixed deposits.
There are attractive opportunities in debt schemes for retail investors, ranging from overnight investment in liquid funds to duration debt products like gilt funds, income fund and dynamic bond funds. Returns from debt funds are tax-efficient than bank deposits.

Decide on the tenor of fund

Before investing in debt funds, one must analyse the risk and return expectation. Liquid funds are ideal to deploy surplus money for a short period of time — even overnight — without losing any liquidity. The money is invested in quality paper with adequate liquidity in the market.

There is no exit load and investors can redeem whenever they want. Ultra short-term funds also provide similar benefits to investors for short-term investments.

Short-term debt funds are ideal for those with an investment horizon of 12 months. The tenure of the debt fund is very important because longer period, there is additional risk and higher exposure to the interest rate fluctuation. As the value of bonds is inversely proportional to the interest rate, a rise in the interest rate will see a fall in the price of bonds and vice-versa. So, a bond with shorter duration has less chance of fluctuation in the interest rate as compared with long-term bonds.

Consistency in returns

Long-term consistency of returns indicate how interest rate risk is managed by funds in delivering a return similar to bank fixed deposits. Ideally, one must invest in those funds that have consistent return performance over a period of 4-5 years.

Analyse credit risk of fund

To minimise credit risk, analyse the portfolio of the fund which is disclosed by AMCs every month. Invest in those funds that rank high on both criteria – consistency of return and portfolio with good credit. Salaried individuals should look at debt funds with low risk. Fund managers may sometimes take higher position in bonds with lower rating for higher returns. But, at the time of redemption such bonds may lack liquidity and investors may not be able to exit the fund. A debt fund with large corpus will mean greater flexibility to diversify into various debt instruments. At the time of redemption, large funds will never have to worry about exiting the investments but small fund will crash because of high redemption pressure.

Interest rate risk

Some debt funds fluctuate more because of changes in interest rate and investors must look at the past performance of the fund house with respect to various interest rate in different period before investing in debt funds. Such an analysis would reflect the performance of the debt fund under different scenario and based on that investors must decide on the amount and duration of investment.

NET VALUE

  • Debt funds give better returns than bank fixed deposits and are tax efficient
  • There is no exit load and investors can redeem whenever they want
  • Long term consistency of returns indicates how interest rate risk is managed by funds
  • A debt fund with large corpus will have greater flexibility to diversify into various instruments
  • Keep watch on the credit worthiness of your debt fund

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