Debt mutual funds are not risky? Here is truth

When it comes to debt investments there seems to be an acute aversion to any sort of volatility among investors. But that need not be the case. In the current market bond yields have seen movements of as much as 100 basis points within a month. There are chances that many investors may want to redeem their debt funds fearing fall in their returns. But what may happen is that investors may miss out on potentially improved returns at portfolio level due to lack of adequate planning.

Understanding price-yield movement

A basic fundamental of bond investing that yield and price are inversely related may not be commonly understood. A simple way of understanding debt funds is to think of them simply as passing through the interest and capital gain income that they receive from the bonds they invest in, after deducting expenses and fees. Unlike fixed deposits, mutual funds invest in bonds that are tradable. Two, in the debt market, prices of different bonds can rise or fall, just like they do on stock markets. Debt market focuses on parameters such as global market development, interest rate cycles, inflation and credit pick-up. Bond prices are affected by the interest rate cycles and policy stance of central banks.

Don’t panic if yields move up

Some investors withdraw untimely from debt funds. The perception that the debt market does not see volatility leads to panic when there is an upward movement in yields which in turn adversely impacts returns during that period. Like in every other asset class, an investor with long-term horizon should remain invested to benefit the most from the interest rate cycle.

Choose the right fund

Debt funds can broadly be categorised in the following three groups:

(1) For short-term investment-Liquid Fund/Low Duration Funds. Good for creating emergency corpus

(2)For medium term investment, defined as 18 months to three years  Short Term fund/Credit Risk Funds

(3)For long-term investment horizon of over three years Bond Funds

Generally speaking, risk matrix in debt funds is measured on two major counts. Firstly, the average maturity of the fund’s investments and secondly the average credit profile of the fund. Higher the average maturity, the more volatile and risky is a fund considered and similarly, the lower the rating profile of a fund’s investment, the more risky is it considered.

By Mahendra Jajoo

(Source: DNA Money)