Equity markets disappointed investors last year and there is no clear sign of a quick revival in the near term. We have to search for such options which can sustain our wealth with acceptable returns in these bearish times. Debt schemes are one such opportunity where you can park your money in these tough times. With further rate cuts expected, debt investment instruments are likely to offer attractive platform to invest in low risk and high yield avenues. Apart from the traditional fixed deposits and provident fund schemes, mutual funds too actively manage debt products. Debt funds seek to invest in various debt instruments whose maturity could be short-term or long-term.Debt funds can be broadly classified as income funds, liquid funds and fixed maturity plans. The classification is based on the nature of instruments and their maturity.
Starting from Income Funds, these funds invest in Corporate Bonds and Government securities. These Funds provide investors with an opportunity to increase returns and generate capital gains, by taking duration bets in a benign interest rate environment.The credit quality of the instruments and the fund manager’s ability to tactically manage the portfolio maturity based on interest rate cycles would determine the performance of such funds.One should be careful while investing in these funds on the portfolio side because sometimes in urge of delivering high returns, the asset quality of the portfolio could be deteriorated. Here we take a look at the various debt funds:
At a time when investors have turned risk averse and credit concerns abound, gilt funds can fill a critical gap in asset allocation. These funds seek to generate steady and consistent returns from a basket of government securities across various maturities through proactive fund management aimed at controlling interest rate risk. These funds will invest in gilt including T-Bills with medium to long maturity. On the back of a possibility of deterioration in corporate credit quality, gilts funds are safer than income funds as Government debt comes with a sovereign guarantee and there is no risk to capital or interest payments
When some one wants to park their money for a very short term, liquid funds is one of the prudent options. These funds invest in short term debt market and money market instruments having very short maturity period, which ensures high liquidity. Liquid funds invest with minimal risk (like money market funds). Usually these funds do not have a lock-in period and offer redemption proceeds within 24 hours. As these funds have restrictions on the quantum of investment in mark-to-market instruments, the interest rate risk is lower. They do not, therefore, benefit from interest rate cycles, unlike income or gilt funds. Liquid-plus funds, on the other hand, can invest in slightly longer-term maturity instruments, thus enhancing the risk-return potential.
They offer flexibility in portfolio constitution according to the perception regarding interest rate movements. Investing in these kind fund are sensible decisions in volatile interest rate when you don’t have time for research and don’t want to shift your options on an active basis.
Fixed maturity plans are close-end funds whose maturity is linked to the expiry of the underlying instruments in which they invest. While FMPs typically help investors lock into the yields of the underlying instruments, such returns would be feasible only if an investor holds on to the fund, until its maturity. Further FMPs carry credit risk in case there is a default on some of the Corporate Papers which they might be holding. While FMPs are no doubt a superior option from a taxation perspective, they are not strictly comparable, as fixed deposits offer assured returns and are not directly linked to market sensitivities once the investment is made.
Floating Rate Funds is another option which is currently out of favor due to expectation of fall in interest rates. These funds have the potential to provide you returns in line with the prevailing interest rate. These should be preferred in times when the interest rates are likely to go up.
To conclude, we think that interest rates are likely to fall further from current levels which would help income funds and gilt funds to deliver good returns. Though, gilt funds have delivered handsome returns recently but still there is some steam left. A conservative investor who does not want to take any credit risk can park their money in gilt funds. The next rally in this category is most likely to be led by Income Funds as they have not seen a major movement yet. Further, the spread between G-sec yield and AAA papers is also very wide. Moderate and aggressive investors with a short and medium-term investment horizon can invest in income funds and can expect decent returns.
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