Hello Readers!
Mutual Fund Investment is broadly divided into two categories, Equity Mutual Fund and Debt Mutual Fund. Debt Mutual fund, we know are short-term investments, that focus its investment mostly in fixed-interest generating securities like corporate bonds, government securities, treasury bills, commercial paper, and other money market instruments.
Debt mutual funds invest in instruments with short maturity and are best suitable for investors who will invest for short-term, say 3 months to 1 year, or moderate-term, say 3 years to 5 years. Also, Debt funds are a good investment option for investors who hold a low-risk profile. Debt mutual funds hold low risk than Equity Mutual Funds.
Debt mutual funds are safer than Equity Mutual Funds, but as they have short maturity, they are prone to many kinds of risks like credit risk, interest rate risk and liquidity risk. Investors of debt mutual funds are advised to consider certain things before they start investing in Debt Mutual Funds, here we are discussing these factors, read to know about them:
Expense Ratio
Expense ratio or Total Expense Ratio (TER) is a kind of operational costs on mutual funds, charged by the AMC (Asset Management Company), to the investors. These charges are applicable to both Regular Plan of Mutual funds and Direct plan of Mutual funds.
The expense ratio in debt funds plays a more important role than in equity mutual funds because the returns or the upside is limited for debt funds. Investors are advised to consider the expense ratio of their debt funds at the start of the investment, they are advised to compare the returns from the funds and the expense ratio charged by the fund. For example, if the return from a debt fund is 9 % and the expense ratio is 1.5 %, then the actual return for the investor will be 7.5 % only.
Thus, the lower the expense ratio, the more the return percent, investors earn from their debt funds.
Maturity and Duration
Debt mutual funds have short maturity, say as short as 6 months, and because of this these funds are more vulnerable towards interest rate risk. Interest rates and bond prices have an inverse relationship.
Modified duration is a price sensitivity of debt fund to change the interest rate, which shows how the change in interest rate affects the NAV (Net Asset Value) of the debt fund.
Longer the modified duration, more is the debt funds vulnerable towards interest rate change and vice-versa. Thus, we conclude that Debt funds with longer modified duration perform well in falling interest rate conditions and funds with shorter modified duration perform well, in rising interest rate conditions.
Hence both the maturity and duration of a debt fund is necessary to be analyzed before you start investing in debt funds.
Yield to Maturity
Yield to maturity is referred to the expected rate of return that the investor gets when they stay invested in debt funds until its maturity period. For example, yield to maturity of a debt fund is 9% means the investor would earn a return of 9% if he holds his investment in debt fund till it’s maturity and the portfolio remains constant until all the holdings in the portfolio mature, however the active management strategy of the fund manager may not give indicated returns as per yield to maturity.
Investors who invest in debt mutual funds for a period of fewer than three years, they are suggested to consider the yield to maturity alongside the credit ratings of underlying securities in the portfolio.
Interest Rate Trends
The changing interest rate in the market impacts the returns from debt funds. When the interest rate falls, the value of the previously issued bonds gets high as compared to the freshly issued bonds, whereas when the interest rate rises, the value of previously issued bonds get lower than the freshly issued bonds and investors get attracted towards the newly issued bonds to invest in as they return with a higher rate.
Debt mutual funds invest in bonds; thus, they perform well in the falling interest rate condition as, during the fall of interest rate, the existing bonds in the portfolio will have a higher coupon rate
Hence while selecting a debt fund to invest, investors should consider the interest rate trending in the market currently.
As of now, you are aware of the factors that are necessary for an investor to consider before investing in Debt mutual funds.
Debt mutual funds have benefits like, short-term maturity, high liquidity, low risks, and good returns that make it a good investing option. Also, debt funds carried for three years or more, opens the option of tax benefits along with the benefit of indexation, to its investors. Thus, investors with short-term investment and low-risk appetite should consider investing in Debt Mutual funds.
Most importantly, do meet a financial advisor, and get every point to point details about Debt mutual fund scheme, also they will help you to plan your investment well according to your goals.
You can also contact us at Shri Ashutosh Securities Pvt Ltd., we are here to help you in any way possible.
Happy Investing!
(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns).