Personal Finance

Why it may pay to invest in debt accrual funds than bank FDs

Dhuraivel Gunasekaran BL Research Bureau | Updated on December 16, 2019

This category of MFs is less volatile, and the returns are taxed lower, too

Many investors use the systematic investment plan (SIP) to invest in equity mutual funds (MFs) but using this route to invest in debt MFs is not so common.

However, SIPs in some debt mutual funds can be quite rewarding.

A BusinessLine analysis of three-year SIP returns for all the debt fund categories shows that the funds under the accrual debt categories — including liquid, low duration, money market and ultra short duration — have managed to deliver higher returns than bank term deposit rates in most periods (see graph).

While debt MF returns may not be as volatile as their equity counterparts, the former are influenced by interest rate cycles.

As the NAV fluctuates across these cycles, SIP investors have the opportunity to bring down their average cost of investment in debt funds. For this analysis, we have classified debt fund categories into accrual funds, duration funds and funds following a mix of accrual and duration strategies.

Accrual funds focus on interest income, while duration funds generate returns from capital appreciation. The former are less volatile, as they are not impacted by the interest rate movement.

A comparison of the three-year SIP returns of debt categories against those of banks’ term deposits reveals that accrual funds managed to outperform in around 90 per cent of the time periods while duration funds and funds following a mix of accrual and duration strategies outperformed in 67 and 74 per cent of the time periods, respectively.

Interestingly, the returns generated by debt funds become more stable as the SIP tenure increases. A comparison of the three-year SIP rolling data with the five-year SIP rolling data of the same scheme shows that the latter set exhibits lower volatility.

The analysis further shows that the SIP returns of some categories of debt MFs were lower when interest rates were at a peak and vice-versa. For instance, when the 10-year G-Sec bond yields hovered at a high of 8 per cent in October 2018, the average three-year SIP returns of the money market, banking and PSU debt and gilt funds were 6.9, 5.9 and 4.5 per cent, respectively. But these funds delivered high returns in December 2016, when the 10-year G-Sec bond yields were around 6.2 per cent.

Investors with a low-to-medium risk profile can channel a small portion of their savings into accrual funds every month based on their investment objectives.

Lower taxes

Debt funds score over FDs and RDs on taxation. The long-term capital gains (redeemed after 36 months) on debt funds are taxable at 20 per cent with the benefit of indexation. As for FDs, the interest income is taxed at the individual’s tax slab.

For this analysis, we used three-year SIP returns (source: ACEMF and NAVIndia) calculated on a rolling period basis, based on the latest seven-year NAV history.

‘Bank Group-wise Weighted Average Domestic Term Deposit Rates’ was used as the benchmark (source: RBI).


Published on December 16, 2019

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