Debt funds are those funds that invest in fixed income securities like commercial papers, company fixed deposits, government securities, corporate bonds, treasury bills, certificate of deposits etc. Debt funds are known to carry a little less risky profile as compared to equity Mutual Funds because they invest in securities that generate regular income over a stipulated period. The volatility rate for debt fund investors is comparatively low. Conservative investors planning on switching to mutual funds for capital appreciation or those who are seeking investment opportunities in mutual funds but do not carry high risk appetite can consider investing in debt mutual funds.
If you are planning to build your mutual fund portfolio using only debt funds, here are a few things that you should understand before investing:
Diversify with the right type of debt schemes
There are around 15 products under debt fund category as per SEBI’s current categorization and classifies. This doesn’t mean that investors should invest in all 15 funds. Therefore, most financial advisors recommend investors to first determine their financial goals so that crafting an investment strategy becomes easier.
Investments in debt funds come at their own cost which investors must pay the Asset Management Company annually in the form of expense ratio. An expense ratio consists of recurring costs such as distributor commissions, trustee fees, fund manager fees, etc. which the fund house levies on debt fund investors in the form of expense ratio. At the time of investment, the expense ratio might feel like just a fraction of a figure which you should not worry about, but, a debt fund with a high expense ratio might impact investments in the long run
Although debt funds are supposed to be less risky than equity-oriented funds, there can be no claims made regarding the same. Before choosing a debt fund, the first question you need to ask yourself is ‘Am I willing to expose my finances to the risks associated with debt funds. There are two types of risks generally associated with debt funds – credit risk and interest rate risk. There are a few debt funds that invest in companies with a high credit risk rate. This may impact the fund’s NAV in the wrong way. Hence, make sure that you have the adequate risk tolerance for investing in debt funds.
Interest Rate Risk/Credit Risk
When the value of the bond in the market goes up, its interest rate goes down. Debt funds are known to carry high interest rate risk. A credit risk is nothing but the fear of the borrower failing to pay the interest rate on the predetermined date. Rating agency CRISIL gives ratings like AAA+, AAA-, etc. to borrowers depending on the financial health of the issuer to determine their ability to repay the promised interest. However, investors should understand that the credit risk of a company will not remain stagnant. Depending on its performance, the company’s credit risk appetite may increase or decrease
Invest in a debt fund managed by a reputed AMC
It is essential that investors consider investing in a well reputed debt fund owned by a. well established AMC. One should always invest in a debt fund that is under experienced management is a better option. The performance of a debt fund majorly depends on the fund manager who buys and sells securities in accordance with the investment objective of the debt fund. Also, a reputed AMC is usually equipped with all the necessary research and analytical tools which should add to its credibility. Hence, make sure that you invest in a debt fund that belongs to a reputed fund house and is managed by a professional and experienced fund manager.
Make sure that you build a well-diversified debt fund portfolio taking above factors into consideration.