Debt funds provides stability to investment portfolio but many investors and distributors find the concept of debt funds complicated. To simplify debt investing, Cafemutual Confluence Investment Marathon 2021 hosted Sandeep Bagla, CEO, Trust MF who simplified debt funds in just 12 minutes.
Here are the key takeaways from the session.
Debt funds
Debt funds are less volatile compared to their equity counterpart and are ideal for risk-averse investors seeking regular income. They invest in fixed income instruments such as debentures issued by corporates, government securities, commercial papers, certificate of deposits, treasury bills, etc.
Government, banks and corporates issue their debt papers which are tradable instruments that promise to pay a regular income and maturity value at the end of tenure. Government bonds could have maturities as long as 40 years while corporate bonds do not typically go beyond 15-20 years. On the other hand, commercial papers issued by companies, certificate of deposits typically issued by banks and government treasury bills have a maturity of less than one year.
Debt fund categories
Factors affecting debt investing
- Inflation expectations - If inflation is expected to decline in future, investors should opt for long term funds, else it makes sense to stay invested in short term/liquid funds
- RBI/central bank stance - Even if inflation goes up and the stance is accommodative, it means that RBI expects the inflation to come down
- Government fiscal policy - It determines how many bonds the government will issue. If government issues large number of bonds, there is high probability that the interest rates would go down
- GDP growth and trade balance - The demand for money is higher during GDP growth and the interest rates may go higher
Additionally, system liquidity along with global yields and monetary policies of global central banks are also important factors that impact debt instruments.
Risks in debt investing
- Interest rate risk - Performance of fixed income funds depends on interest rate changes and bond maturities. If the interest rate goes up, the asset value goes down. Also, longer the maturity, higher is the volatility with respect to interest rate movements
- Credit risk - It depends on the repayment quality of underlying assets. Higher the credit quality lower is the chance of default
- Liquidity risk - It is the ability to convert an asset into cash without significant loss of value. Higher liquidity hints at lower impact cost.
In the current scenario where investors are looking to create a 6-month/12-month emergency fund, it is recommended to have an equal proportion of investment in liquid funds and short term funds. Investors with a time horizon of 3 to 5 years can hold 20% in income funds and also explore funds with roll down structures for avoiding interest rate risk.
Watch this video to know how Sandeep decodes debt investing.
