Mutual Funds

The case for debt funds

Maneesh Dangi | Updated on February 09, 2013


Even today, a conservative Indian investor continues to confuse mutual funds with equity. It is precisely because of this lack of understanding that he misses out on the superior risk-adjusted returns, easy liquidity and tax benefits that fixed income funds have to offer.

Today, 72 per cent of the aggregate assets of the mutual fund industry in India are invested in debt funds, thus marking the prominent position that fixed income funds hold in the asset management space.

While most retail investors do have a fair idea of the conventional financial instruments such as bank fixed deposits, gilts, company non-convertible debentures, they seem to be unaware of the fact that fixed income funds in India, in fact, invest in various combinations of these instruments only.

The portfolio exposure (as of November 2012) at the industry level shows that of the entire fixed income assets, about 10 per cent is invested in G-sec, 53 per cent in corporate securities and about 36 per cent is invested in bank FDs.

It is thus, important to understand that fixed income funds are nothing but a conduit to invest in such securities, only in a more efficient manner. Not just this. Investors, through these funds, get the opportunity to choose from various schemes depending on their risk appetite and the desired tenure — short term funds, liquid funds, fixed maturity plans and so on.

But is variety a good enough reason to shed your conventional thrift habits and shift to savvy fixed income funds? Certainly not, but fixed income funds have much more to offer.

Sound investment philosophy germinates from prudent portfolio diversification, and that is exactly what debt funds do. The idea is to invest in the right securities at the right time and in the right proportion to garner the highest returns. Such a task requires expertise and skill which a retail investor may not possess due to his distance from the intricacies of the market.

Apple-to-apple comparison

While a typical Indian retail investor is always more keen to invest in bank FDs, what usually skips his mind is the threat posed by volatility in inflation trajectory, which is inevitable in a developing economy.

So when you lock in your money for a fixed tenure at a certain rate with an anticipated trajectory of inflation, the math completely falls apart if inflation starts to misbehave and eats into your returns.

It is here that the flexibility and agility of the fixed income funds play a pivotal role in securing better real returns through prompt portfolio re-allocation.

Very often, investors start comparing pre-tax current return on FDs with the past performance of various debt schemes and jump to the conclusion that FDs are better. But that is incorrect.

What they should technically compare is the post-tax return on FD in the same time span for which they are looking at the return on debt schemes.

And once they do start comparing apples with apples, they’ll see how tax-adjusted returns from debt funds can be superior to those offered by bank FDs.

Apart from these, the ease of liquidity that fixed income funds offer vis-à-vis bank FDs and the like cannot be overlooked.

If you withdraw your money before maturity from an FD, you are liable to a monetary penalty, but, if you have invested with a debt fund you can redeem your units anytime you like without losing the gain accrued to you till that date! They allow small savings too. Imagine opening an FD for Rs 2,000-3,000 every month!

It is then difficult to justify as to why the retail investor participation in fixed income funds in India is so low, even when the institutional investors are, in fact, making good returns from the same.

The usual answer is the fee that they are charged. But is that a reasonable justification? You are ready to pay a doctor his fee for your diagnosis, even when you have the option of using the tried and tested nani maa ke nuskhe, then why this discrimination in case of financial services?

The fee that the fund houses charge is for the expert guidance that they provide as the care taker of your money while bearing the onus of delivering superior returns time and again.

I think it’s time the retail investors, for their own benefit, move on to fixed income funds and take advantage of professional fund management expertise at low cost, which is already benefiting their institutional counterparts.

(The author is co-Chief Investment Officer, Birla Sun Life AMC)

Published on February 09, 2013

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