How does duration funds work and how should one invest in these funds?
—Ravi Sharma
A fixed-income investor should allocate exposure to different debt fund categories (short-term debt, medium and/long-term debt, and credit) based on his/her recommended asset allocation, which in turn is dependent on the investor’s risk appetite. Shorter duration funds (short duration, corporate bond, etc.) provide accrual yield and subject investors to relatively lower market-to-market risk. Longer duration funds (medium-to-long, long duration, etc.) offer a higher yield compens-ating investors for the maturity (duration) risk, and present an opportunity for significant capital appreciation in a falling interest-rate cycle.
However, these would deliver subdued performance when interest rates move north. Funds taking exposure to corporate securities offer additional yield to compensate investors for taking on credit risk.
Also Read: SBI Long Duration Fund: NFO which may provide more benefits than Fixed Deposit – Check details
Investors should ideally follow a core-satellite approach, with the core (70%) of the portfolio invested into high credit quality (safer) shorter-duration funds to minimise credit and duration risks, while the satellite portion of the portfolio can be allocated to longer-duration and credit-risk funds. Investors taking tactical calls based on their expectations on the various segments of the yield curve, may allocate higher exposure to the non-core segment of the portfolio. Like equities, fixed-income funds too are prone to the risk of capital loss. Investors should diversify their holdings across two or more funds and/or fund-houses, to avoid concentration to the interest rate / credit related calls of a fund manager / fund-house.
Also Read: Longer-duration debt funds start seeing traction
As I have got a bonus, should I invest the amount in a lump sum or increase my SIP amount?
—Arjun Kumar
An asset allocation-based approach should be followed for investing towards one’s goal. While fixed-income lends stability to the portfolio, equities play a crucial role in wealth generation over the long run with a potential to deliver superior inflation-adjusted returns compared to fixed-income. For deploying the additional corpus, evaluate your portfolio from an asset-allocation point of view and build exposure in line with your recommended asset allocation. One should also evaluate the sector and style diversification (value/ growth) at a portfolio level, and also the extent of overlap in the equity funds in your portfolio to assess the true degree of diversification that the portfolio equity funds offer. You should look to diversify your portfolio across two or more funds (depending on desired sub-asset class exposure and investable corpus) to reduce concentration to the calls of a single fund manager.
Consider 10-25% of your equity allocation to international equities as these offer diversification across geographies with exposure to diverse growth drivers, and also offer a hedge against the depreciation of the rupee. One should be cognizant of the prevailing valuations while entering any asset class.
The writer is director, Investment Advisory, Morningstar Investment Adviser (India). Send your queries to fepersonalfinance@expressindia.com