I wish to do lump sum investment in debt/liquid funds for three years up to ₹6 lakh. Please suggest funds to invest ₹1 lakh each.


You have stated that your time horizon is three years. Three years could be a feasible time frame for holding debt mutual funds in one’s portfolio. This time period not only helps attain desired returns but also qualifies the investment for indexation benefit for tax purposes. In growth plans of debt funds, units sold after 36 months qualify for long-term capital gains (LTCG) tax at 20 per cent (plus surcharge and cess, as applicable) after indexation benefit on the gain.

You can expect a CAGR (compounded annual growth rate) of 7-8 per cent (pre-tax) from your debt funds portfolio. Please note, debt mutual funds are exposed to credit risk and interest-rate risk. Essentially, the NAV (net asset value) on your debt fund can rise or fall along with the underlying bond prices. One factor that impacts bond prices is interest rate. Interest rates and bond prices have an inverse relationship. If the interest rates move up, bond prices fall (as investors prefer newer bonds offering higher rates).

Credit risk arises when a debt fund invests in low-credit-quality debt securities which may default on repayment. Over the past two years, a spate of corporate bond downgrades and defaults have impacted the performance of several debt funds.

Since debt funds carry market risk, it is important to choose debt funds with features such as relatively lower credit risk, portfolio diversification, short-to-medium maturities and inherent high liquidity. Based on the above criteria, four debt schemes are suggested for you — ICICI Pru Liquid, Aditya Birla Sun Life Floating Rate Fund, Kotak Banking and PSU Debt fund and IDFC Dynamic Bond Fund. You can spread your investment across these schemes.

ICICI Pru Liquid is one of the best-performing funds in the category. Liquid funds invest in debt and money market securities with a residual maturity of up to 91 days. ICICI Pru Liquid focuses mainly on accrual income by investing in high-quality debt papers. Its portfolio average maturity has been maintained between 31 and 60 days over the last one year. One can expect liquid funds to deliver similar or slightly higher returns than bank FDs. Liquid funds provide one of the best avenues to park your emergency funds, offering you instant redemption facility of up to ₹50,000 or 90 per cent of the invested amount.

Aditya Birla Sun Life Floating Rate Fund has been one of the top-performing schemes in the category. It invests at least 65 per cent of its portfolios in floating-rate instruments including fixed-rate instruments converted to floating-rate exposures using swaps/derivatives. Since the availability of floating rate bonds is limited, the fund adopts Interest Rate Swap (IRS) strategies to meet the 65 per cent threshold limit. This strategy also reduces the interest-rate risk caused by rise in interest rates. It is rated five-star by BusinessLine Portfolio Star Track MF Ratings .

Kotak Banking and PSU Debt is the top quartile fund across periods in the category. As the name suggests, banking and PSU debt funds invest at least 80 per cent in debt instruments of banks, public sector undertakings, public financial institutions and municipal bonds. The balance is invested in government securities and corporate bonds. Kotak Banking and PSU Debt is one of the few funds in the category allocating only to the debt instruments issued by the banks (private & public), public sector undertakings (PSUs) and government bonds. Its portfolio average maturity has been maintained between 2 and 4.6 years over the last three years. It is rated four-star by BusinessLine Portfolio Star Track MF Ratings .

IDFC Dynamic Bond Fund has allocated its assets only to the highest-rated debt instruments (AAA rated and G-Secs) over the last six years. It is rated four-star by BusinessLine Portfolio Star Track MF Ratings . Note that dynamic bond funds are suitable for investors with a high risk profile as they are exposed to interest-rate risk.