Despite some recent jolts that many debt fund schemes have suffered due to a series of debt failures after the IL&FS debacle, such funds still score over bank fixed deposits.
Despite some recent jolts that many debt fund schemes have suffered due to a series of debt failures after the IL&FS debacle, such funds still score over bank fixed deposits (FDs) due to their ability to beat inflation and provide tax-efficient long-term capital gain (LTCG) along with excellent liquidity. However, the maturity values in FDs are predefined as the interest rate remains fixed for the tenure of the deposit, which is not for debt funds, where returns may vary from category to category and funds to funds.
“There is more than a dozen categories of funds available in debt segment, including debt oriented hybrid schemes. In India, whether you wish to invest for just 1 day or for 10 years, different debt mutual fund (MF) categories are available as per your preferred time frame. Therefore the problem today is to choose the best suitable scheme according to the person’s need,” said Financial Coach & Corporate Trainer Prof. Rahul Ranjan.
Talking on categorisation, Ranjan further said, “Debt funds can be broadly categorised into Accural and Duration Schemes and both have their own pros and cons”
“Accural funds are considered to be safe and can be used as better and tax efficient alternative to bank fixed deposits, since fund managers concentrate on holding the bond, collecting the coupon/interest, taking back principal and then re-investing in next bond,” said Ranjan while explaining functioning of accrual funds.
“Some of the available accrual categories in India are – Overnight funds, Liquid Schemes, Ultra Short Term Funds, Low Duration, Short Term Bond Schemes, Corporate Bond Schemes and Credit Risk,” he added.
Highlighting risk factors, Ranjan said, “The biggest risk faced by these accrual funds is credit downgrade and default. As we have recently seen IL&FS and DHFL Bonds.”
Talking on alternative option, Ranjan said, “In duration based funds fund managers try to get benefit of ups and downs of interest rate cycle. When interest rate falls, bond prices rises. When interest rate rises, bond prices falls. The higher the modified duration the impact in bond prices will be higher with each fall or rise in interest rate. Gilt or Government Securities generally have a very high modified duration. The good part is that it doesn’t have any default risk.”
“Duration funds are two stripped sword. It can give you a very good return under under favourable situations like falling interest rate. But if interest rate goes up long duration fund can snatch away everything and can give you double digit negative return,” Ranjan further said, adding, “Therefore a retail investor should avoid duration based funds and invest in accrual funds.”
So, despite considered as relatively safer investment, debt funds do have some inherited risks and hence, investors should be careful while selecting a fund.
“The role of a good financial advisor is extremely important while selecting, investing and even when exiting the debt funds. Therefore help of a very knowledgeable financial advisor, who has specialised in debt market, should be taken while entering the segment,” said Ranjan
“Investor should select only those Debt Schemes from the AMC’s who has a better track record of managing debt funds,” he added.