With the volatility surrounding equity markets, many investors are finding solace in debt funds. But before recommending debt funds to your clients you need to find out their risk appetite and time horizon.
Risk appetite will help you diversify client portfolio. Since debt funds are meant to protect investors during volatile times by providing stable returns finding the risk appetite and investment horizon will help you select the ideal debt fund for your client.
But is it the right time to invest in fixed income? We asked fund managers and IFAs as to what are they advising investors.
Lakshmi Iyer, CIO, Debt & Head Products, Kotak Asset Management says “Fixed income schemes provide investment solution for almost every interest rate cycle. It’s not a rule of the thumb but one can invest in fixed maturity plans when interest rates are rising, while they are falling gilt funds are the way to go and during static interest rate scenario investors can select liquid funds.”
Suresh Soni, CEO, DHFL Pramerica MF recommends investors to invest in medium term and accrual funds at this juncture. “Despite significant moderation in inflation over the last couple of years and continuous improvement in other key metrics like current account deficit, government fiscal deficit, interest rates have remained relatively high. Further, the chances of rate cut have increased post the recent cuts in small savings rates and the fiscal prudence demonstrated in the latest Union Budget 2016. I find fixed income investments quite attractive on the risk-reward spectrum and would recommend investors to allocate money to medium-term and accrual funds.”
Delhi based IFA Pallav Agarwal says “Debt funds can be used as asset allocation tool. Investors with an investment horizon of three to four years could invest in debt funds while those with a longer term view of five years and above could invest in hybrid funds.” But Pallav strictly advises his clients to invest in investing high credit quality funds.
Returns from different categories of debt funds
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*data source: Valueresearchonline as on 29th march 2016
But before investing in debt funds, we need to look at factors beyond returns to suit investor’s risk-return profile. Here are a few important check lists while selecting debt funds.
Asset Allocation: It helps investors understand the approach of the fund manager. Debt funds invest in government, quasi-government securities and corporate bonds and the portfolio mix helps us understand the strategy deployed by the fund manager. For instance, a higher percentage of government bonds would fetch higher return in case of falling interest rate scenario while a higher tilt towards PSU or corporate bonds will yield better interest income, which is more suited for investors with a higher risk appetite.
Credit Risk and Ratings: The paper in which debt funds invest are rated by agencies such as CRISIL or CARE, which indicate the credit worthiness of the borrower. Higher the rating more the credit worthiness of the borrower and vice versa. Higher rating can yield lower return as compared to a bond issued by a company with lower credit rating. This is because lower rated paper may offer higher return for the risk taken by investors. Credit risk indicates the profile of the portfolio that the fund has assumed. A large portion of investments in government bonds indicates a lower credit risk.
Maturity profile: This is the percentage bifurcation of maturity of all holdings of the portfolio. This helps us understand the average maturity of the fund and to what extent it is exposed to interest rate risk. For instance, in case of a falling interest rate scenario, most debt funds have a higher maturity.
Average Duration: The duration is the price sensitivity to the change in interest rate. Longer the duration more sensitive is the bond to a given change in the interest rate. For example, if interest rate goes down by 1%, the price of the bond will go up by 3% if the modified duration of portfolio is 3 years.
Yield: Yield is the measure of return generated on a bond. So higher coupon rate indicates higher yield.
