Invest in right debt fund for larger gains

Asset allocation is the key and so when investing one needs to diversify according to their risk appetite. Actually, even a riskier investment avenue could be neutralized by having an appropriate mix of an uncorrelated investment.

This brings to highlight the importance of having portfolios while investing in mutual funds (MF). And for most investors, the very mention of MF brings the image of equity investments and the risks or returns associated with it. More particularly, the higher assumption of both the risk and returns is a common malaise. The underlying belief is mostly due to the lack of awareness and knowledge in the available choices.

Debt is nothing but raising a fund with a commitment to repay with an agreed consideration or simply loan. In the business world, the corporates raise funds through equity, debt or mezzanine (debt convertible to equity) for conducting or expansion of their business. For the investors, debt unlike equity doesn’t completely transfer the risk of their investments.

In most cases, the debt is secured through a collateral or asset, so there is a fall back in case of a default by the company. And debt also helps the investor earn a consistent and constant income for a particular period through interests. This makes debt instruments attractive to a particular set of investors and for those with lesser risk tolerance. 

These debt instruments are also issued, traded and exchanged similar to that of the equity instruments. Depending upon the commitment or holding period, these are broadly classified as short-term, medium-term and long-term bonds. Of course, there are instruments which are issued and traded for a period of less than a day or overnight. These instruments form the call money which are dictated by call rates depending upon liquidity in the system. 

Debt MF predominantly invest in fixed income instruments like treasury bills, government securities, bonds etc, to generate long-term capital appreciation. Most risk-averse investors restrict their options to bank deposits and some might even explore highly rated corporate deposits. But, debt MFs offer some very dynamic options to explore within this space with flexibility of timelines stretching beyond the general 3-5 year fixed/company deposits. 

Most of the debt MFs are open-ended while investors trying to time their investment returns could explore the option of closed-ended funds like fixed maturity plans (FMP) which are similar to bank FDs, though the taxation on the long-term (3years and above) would greatly benefit the investor. Also, for investors looking for the short period of less three months could look for opportunities in short-term, ultra-short and liquid category of MFs.

For instance, savers who are looking for parking their kids’ school tuition fees, then they could check for ultra-short or liquid fund space instead of retaining them (the money) in their regular savings bank account.

One could not only earn better returns than a bank account but also are highly liquid with the availability of funds in the bank less than a day on any working day between Monday and Thursday. Also, there are efforts by certain mutual fund houses to connect with apps or debit cards to make available these funds for instant redemption with certain limits and for shopping or purchasing purposes. 

Investors looking to earn better returns could explore the bond fund MF vehicles which predominantly invest in securities with accrued interest. Moreover, depending upon the interest rate and liquidity these bonds are traded and could result in profits through capital gains. These funds are classified as accrual funds. 

Investors should however, be aware of the expectation mismatch. Most investors would invest with a three-year horizon while trying to judge their performance on a six-monthly basis. This could result in misjudging or making wrong assumptions as in the short run these funds could be volatile.

Then there are funds which purely invest in government securities or G-secs popularly known are gilts. These instruments despite carrying a sovereign guarantee are highly prone to volatility due to the changes in macro-economic conditions, government policies and exchange rates. These funds are classified as duration funds.

A mix of both accrual and duration instruments is also available through dynamic bond funds. The fund manager takes exposures in both categories of instruments depending upon their conviction on the overall bond market with a time horizon.

So, it’s highly critical for investors to understand the underlying instruments in these funds and the timelines associated with. If these match with their investment philosophy, then investors stand to make larger gains through investing in debt MFs. (The author is co-founder of “Wealocity”, a wealth management firm and could be reached at knk@wealocity.com)