Personal Finance

Park your money in low-risk debt MFs

Dhuraivel Gunasekaran | Updated on September 15, 2019 Published on September 15, 2019

Debt funds may not be as risky as equity funds, but they come with the possibility of capital erosion

Debt mutual funds are often sold as an alternative to bank fixed deposits. But they are not entirely risk-free. Though debt funds may not be as risky as equity funds, they do come with the possibility of capital erosion.

Over the past 12-15 months, a spate of corporate bond downgrades and defaults have impacted the performance of debt mutual funds. Bonds issued by IL&FS, DHFL, Essel Group and Reliance ADAG Group were all been downgraded sharply. This led mutual fund companies marking down such distressed assets in the portfolio of the schemes that held them. Many debt funds, including liquid funds, witnessed a significant drop in their NAV (net asset value).

Given that the credit quality issue in debt instruments has been persisting for some time, investors can consider debt fund categories that focus on high credit quality, short-to-medium maturities and inherent high liquidity. These include overnight funds, liquid funds, money market funds, corporate bond funds, and banking and PSU debt funds.

Investors can choose debt schemes which have diversified allocation to different types of debt instruments. Such diversification offers liquidity while mitigating credit risk.



Overnight funds

Overnight funds are considered to be of the lowest risk among debt funds as they invest in securities with residual maturity of around a day, such as repo, tri-party repo (TREPS), certificates of deposit (CD), commercial papers (CP), Treasury Bills (T-Bill) and cash management bills.

These funds carry very low credit risk as the default risk in the above-mentioned papers is very low. Further, given their one-day maturity, interest rate risk in these papers is almost nil. (The prices of bonds increase when the interest rate in the economy falls, and vice versa. Changes in interest rates inversely impact bond prices. This is known as interest rate risk.) Investors who want to park their idle money for a short term, say, a day or a month, or to manage their emergency funds, can consider investing in overnight funds.

Liquid funds

Liquid funds invest in debt and money market securities with a residual maturity of up to 91 days. They invest mainly in TREPS, CDs and CPs. Recently, SEBI mandated liquid funds to follow only the mark-to-market method of valuation while computing NAVs. This may increase the volatility marginally in their returns going ahead. The interest rate risk and credit risk in liquid funds are slightly higher than in overnight funds.

Surplus short-term money or emergency funds can be parked in these funds. One can expect similar or slightly higher returns than bank FDs.

Money market funds

Money market funds invest in money market instruments having a maturity of up to a year, such as repo agreements, Treasury Bills, CDs and CPs. Funds in this category mainly follow the accrual strategy (relying on interest income).

Since the average maturity of their portfolio has been kept around one year, they are less impacted by interest rate risk. The exposure to lower rated bonds is also low.

Corporate bond funds

Corporate bond funds have the mandate of investing at least 80 per cent of their assets in AAA and AA+ rated corporate debt papers. The balance is invested in relatively lower rated bonds, money market and repo instruments.

These funds generate income by adopting both strategies — accrual (relying on interest income) and duration play (benefiting from capital appreciation by churning assets based on interest rate movement in the economy).

Most funds in this category maintain an average maturity of around three years and take tactical moderate duration calls when opportunities arise. Large allocation to the highest-rated papers mitigates credit risk.

Banking and PSU debt funds

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.

In India, the debt papers issued by PSU companies (which are backed by the Centre) and banks boast a relatively higher credit rating. These funds follow both accrual and duration play strategies.

Investors with medium-risk appetite who want higher returns than bank FDs can consider investing in money market funds, corporate bond funds, and banking and PSU funds.

Published on September 15, 2019

A letter from the Editor

Dear Readers,

The coronavirus crisis has changed the world completely in the last few months. All of us have been locked into our homes, economic activity has come to a near standstill. Everyone has been impacted.

Including your favourite business and financial newspaper. Our printing and distribution chains have been severely disrupted across the country, leaving readers without access to newspapers. Newspaper delivery agents have also been unable to service their customers because of multiple restrictions.

In these difficult times, we, at BusinessLine have been working continuously every day so that you are informed about all the developments – whether on the pandemic, on policy responses, or the impact on the world of business and finance. Our team has been working round the clock to keep track of developments so that you – the reader – gets accurate information and actionable insights so that you can protect your jobs, businesses, finances and investments.

We are trying our best to ensure the newspaper reaches your hands every day. We have also ensured that even if your paper is not delivered, you can access BusinessLine in the e-paper format – just as it appears in print. Our website and apps too, are updated every minute, so that you can access the information you want anywhere, anytime.

But all this comes at a heavy cost. As you are aware, the lockdowns have wiped out almost all our entire revenue stream. Sustaining our quality journalism has become extremely challenging. That we have managed so far is thanks to your support. I thank all our subscribers – print and digital – for your support.

I appeal to all or readers to help us navigate these challenging times and help sustain one of the truly independent and credible voices in the world of Indian journalism. Doing so is easy. You can help us enormously simply by subscribing to our digital or e-paper editions. We offer several affordable subscription plans for our website, which includes Portfolio, our investment advisory section that offers rich investment advice from our highly qualified, in-house Research Bureau, the only such team in the Indian newspaper industry.

A little help from you can make a huge difference to the cause of quality journalism!

Support Quality Journalism
This article is closed for comments.
Please Email the Editor
You have read 1 out of 3 free articles for this week. For full access, please subscribe and get unlimited access to all sections.