How to invest in Debt Mutual Funds?

How to invest in Debt Mutual Funds?

Debt markets over the last year have been through turmoil with the wake of a downgrade of IL&FS. Post this event, several skeletons came out of the closet which eventually has kept investors at bay. However, all is not wrong in this space. Investors having a lower risk appetite can still make decent returns. Given this fear and uneasiness about this category, let us discuss debt mutual funds

What are debt mutual funds? We know what types of mutual funds can either be equity based, debt based or hybrid (invests in a mix of equity and debt schemes). Equity mutual funds invest in shares of many companies

Debt mutual funds invest in a wide variety of papers issued by various institutions such as governments, financial institutions, companies, etc. These papers range from government treasury bills, repos, commercial paper, certificate of deposits, corporate debt etc. Unlike equity funds, they do not directly invest in shares of companies but invest in the papers issued by them. This is the reason why the risk level for these funds is very less as compared to equity funds

The taxation for the debt mutual fund category is also different. Long term capital gains (LTCG) is calculated if the holding in these funds is 36 months or more, whereas short term capital gains (STCG) is for a period of less than 36 months

LTCG comes with the benefit of indexation thereby making the taxation almost nil if funds are held for the long term. STCG is calculated at the rate of 20%, unlike 15% as in the case with equity funds

Types of risks associated with debt funds There are various categories of debt funds in the market and investors can make a choice basis their needs. Let us understand a few risks associated with debt funds that will help us make a wise choice for our investments: -

• Credit rate risk: In case the company does not generate enough profits, it won’t be able to pay off its debt investors
• Interest Rate risk: If we have already invested in a fund and the interest rates spikes, the value of the bonds with have an inverse relationship to the interest rate drops significantly. The opposite happens in case of interest rate drops
• Liquidity Risk: There are some funds which are not liquid in nature, meaning they are not tradeable. So in case we want to sell these funds, we might have to do it at a discount, thereby incurring losses
• Concentration risk: This risk arises when the level of concentration to a particular issue or sector is more than anticipated. In the given market situation, sectors such as real estate firms, NBFCs, Telecom etc. may fall under this space

Best 6 debt funds across various investment horizons Now that we know about these funds and risks associated, let us look at a few of the best debt mutual funds in the market. Investors should know that suitable investment horizon for various debt funds varies as per the category

Funds
• IDFC Dynamic bond fund
• Aditya Birla Sun life Corporate Bond Fund
• Axis Banking & PSU Debt Fund
• HDFC Short Term Debt Fund
• Franklin India Savings Fund
• Axis Treasury Advantage Fund

The above funds have been curated basis their performance and covers entire range of ideal investment horizon based on investor’s choice (from 6 months to 7 years). All these funds fall under the top rated category as per Groww’s ranking and have consistently generated alpha for investors. The fund managers of these schemes have navigated through the tough times by sticking to quality papers and thereby generated benchmark beating returns consistently across various time periods

Conclusion Most investors prefer to invest in equity mutual funds given the higher returns generated by them. However, there are always volatile times in the markets and one should allocate at least some part of their portfolio towards debt schemes. Debt funds not only diversify our portfolio but also provide almost tax free return if held for more than three years (because of the benefit of indexation)

Happy Investing!