Debt mutual funds invest in fixed income securities like bonds, treasury bills, government securities, Money Market Instruments, and any other debt instruments. Such debt mutual funds are available in the form of Monthly Income Plans (MIP), GILT funds, Fixed Maturity Plans (FMP) etc.
Debt Mutual Funds are different from regular equity mutual funds and offer various other advantages which seldom are known. This article will sum up everything with respect to Debt Mutual Funds and its relevance in current scenario.
How debt funds are advantageous and when?
Capital gains are long term only if the debt mutual funds are held for 3 years or more. If you want efficient-taxability of the capital gains on mutual funds, then you can be invested in mutual funds for the period of 3 years or more. Such long-term capital gains are allowed benefit of indexation and 20% tax rate is applied after such indexation. Hence, these funds can be used as tax management tool for those who are in high tax bracket.
Market linked returns
Debt mutual funds generate superior returns as compared to other conventional fixed income securities, especially where the interest rates are falling. Reserve Bank of India is cutting rates from quite some time now and in recent monetary policy it changed it’s accommodative stance to neutral by keeping repo rate unchanged at 4%. Looking at falling interest rate scenario, we have experienced that this has resulted in reduction of interest rates of bank fixed deposits. On the contrary bond prices have risen as they have inverse relationship with interest rates. This will lead to increase in returns from the debt mutual funds. Since there won’t be major interest rate rise in coming future, debt mutual funds can be a safe bet for risk adverse investors to earn better returns as against bank fixed deposits etc.
Better liquidity as compared to bank deposits
Bank deposits are not transferable and cannot be withdrawn partially or even are levied premature withdrawal charges for premature full withdrawal. Debt mutual funds stand in a better position with respect to liquidity as it can be partially redeemed or withdrawn. However, keep a check on exit load within lock in period which may be between 6 months to 3 years. Some of the debt funds levy exit load of 0.5% to 2%, if redeemed or sold within lock in period.
Superior returns and moderate risk
Since, falling interest rates make debt fund returns look good, these funds can even give you more than bank fixed or recurring deposits, at slightly higher risk than conventional bank deposits (due to interest rate risk).
Even in case of global economy impact on domestic economy, the investor can minimize such incidence of global recession or slow down, where FII may take out capital and returns from equity market and flee. This may result in chaos in stock markets and ultimately hamper your equity related mutual funds. So, you can stay safe by investing in debt mutual funds, which may fetch lower returns as compared to equity funds (but higher than conventional bank deposits) but may be a lot safer.
Current economic situation and Debt mutual funds
Pause on Rate cut by RBI
In the current scenario where RBI has put a hold on further rate cut in recent announcement of monetary policy, What should you do as a Debt Mutual Fund investor?
How will it impact Debt Mutual Funds?
Well, debt market will not be impacted much and looking at falling interest rates as RBI has already cut 115 basis points starting this year and is expected to reduce further in future, it is suggested to focus on shorter duration funds, corporate bond funds, banking funds, PSU funds. Also, stick to AAA funds.
As RBI consecutively been implementing the Repo rate cut, resulting the interest rate to fall. This has resulted in downward trend in bank deposit rates and any other conventional investment instrument return rate (which is linked to Repo rate). Currently, bank allows interest rate of 6.5-7% interest rate, maximum interest rate on deposits being 7-7.65% for senior citizens. This situation is perfectly ideal for investment in debt funds as it is moderate risk investment alternative but with superior returns as compared to bank deposits.
Global slow down owing to COVID-19
As stated by RBI governor,”Global economic activity has remained fragile; surge in COVID-19 cases has subdued early signs of revival.”
The stock market in recent time has been very volatile. This economic slowdown owing majorly to lockdown amid COVID-19 and volatile stock market is making many investors nervous and confused about their investments.
Foreign Institutional Investors (FII) are the entities which are affected the most by the market trends and economic changes. So whenever, stock market is going through volatile phase, FII will sell out, causing the stock market to come down even further. This will disrupt the equity linked mutual funds, so this is a right time to go for debt mutual funds amid uncertainity, since these funds invest in government securities and other fixed income securities.
Ideally, the current economic situation is better for investing fresh money in debt mutual funds as they fetch better returns than bank FDs and are less risky than equity and equity linked mutual funds. Thus, for short term goals, it is recommended to go for Debt Mutual Funds.
Stay Safe, Stay Invested!
How many of you are familiar with STPs?
I’m sure not many of you. Now with so many investment options available, people are confused in what to invest, where to invest and how to invest. Some people do not know what are the investment options available, and how to make the best use of them.
You may have different goals and dreams in life, but to fund those goals is a big task. It is always suggested that if you don’t know your way through the market, you seek help from an advisor. They will be able to guide you in the right path and help you build a bridge between your funds and goals.
You must be aware of Systematic Investment Plan (SIP) which is one good option to invest in mutual funds. In SIP, a fixed amount is deducted from your savings account every month and directed towards the mutual fund you choose to invest in. Systematic Investment Plans are a disciplined way to start investing to create wealth for the longer period of term.SIPs bring about a good saving habit in one’s routine, which is necessary.
Read More :- Importance of Continuing SIPs Amid COVID-19
Another option is STP (Systematic Transfer Plans), this is good for those investors who do not want to take the risk of investing a lump sum amount in a particular fund at one go. Especially in the current scenario, where the market is volatile due to COVID-19 pandemic, it is suggested to not invest lump sum. So Systematic Transfer Plans comes to your rescue.
Under Systematic Transfer Plans, an investor can invest a lump sum amount in a fund and transfer regular amounts, which are predefined by the investor, to another fund, on a specified date. You can make these transfers on a monthly, quarterly or even weekly basis. This is a better option than directly investing the whole lumpsum amount in a risky fund.
There are 2 types of STPs:
- Fixed STP: Over here, the amount that is to be transferred from one scheme to another is fixed. For example, Mr. A invested Rs. 100000/- in a fund ABC, and he has opted for a STP to fund XYZ, he wants Rs 5000/- to be transferred to fund XYZ on a monthly basis. Here we can see that Rs. 5000/- is the fixed amount that is to be transferred.
- Capital appreciation STP: Under this, the amount that is to be transferred will depend on the profit earned. This means that the investors want only the profit amount to be transferred to the other fund. Let us take the same above example to get a better idea, If after investing Rs. 1 lakh in fund ABC, he gains Rs. 6000/- (after a few months or a year) on it, the same amount of 6000 will be transferred to fund XYZ.
Now lets see how STP is relevant to you.
If an investor, who has a lump sum amount to invest, doesn’t want direct exposure in the equity market, can invest his lumpsum amount in a debt fund and through STP, transfer the amount he wishes to in the equity fund.
He can make the transfers monthly, quarterly or even weekly, as he wishes. However, one must keep in mind that, whenever an amount is transferred from one fund to the other, the units of that fund, from which money is going out, becomes less and units of the fund where the money is transferred increases.
Lets say, if the funds are being transferred from debt to equity, then the units in the debt fund will reduce and the units in the equity fund will increase.
Read More :- Understanding SIP, SWP and STP
STPs from debt to equities are more effective, when markets are volatile, and an investor does not want to take a risk. STPs are a better option than one time investments, in cases when the market is down which we are experiencing right now because of global pandemic. However, if we look at it the other way round, then one time investments would be a better option, if the markets are moving upwards. Having said all this, it is very difficult to predict the market scenario for a retail investor. So it is better for them to invest through STPs and get better risk adjusted returns, over a period of time.
STPs help investors reduce their risk, if the regular transfers are maintained. Just like how the concept of Rupee Cost Averaging works for a SIP, it can be applicable to a STP also. People usually think that when the market is down, they should redeem their money, before they make a bigger loss. However, people investing through SIPs, can avail this benefit.
Let us continue with earlier example to understand above point:
Mr. A invested Rs. 100000/- in a fund ABC, and he has opted for a STP to fund XYZ, he wants Rs 5000/- to be transferred to fund XYZ on a monthly basis. Now let us say in the 1st month, the NAV of fund XYZ was Rs. 10/-. So the no. units added will be 500 (5000/10). After a few months, if the NAV drops to Rs. 8/-, 625 (5000/8) more units will be added to the XYZ fund compared to 500 earlier.
In this example, you can see how an investor can take the advantage of the market when it drops. This example is taken also with a few months gap. Now, imagine if an investor keeps his money for years, how much will he gain.
STP is a tool to reduce risk, like SIP. The transfers should be made in a disciplined manner to avail this benefit. Well now you’ve understood all you need to know about STPs, so you can start planning for your investments, and make use of the funds you have in a proper and ‘Systematic’ way even during the current volatile market owing to COVID-19.
Debt funds are basically mutual funds that are invested in fixed income securities like bonds, treasury bills, govt. securities, money market instruments. These bonds can be short term, medium term and long term. The maturity is for a fixed period. The returns are not that high as compared to equity, but they are linked to the market performance of the securities they are invested in. Debt funds ensure the investor that his money is safe and doesn’t have much risk.
Let us see some of the features of debt funds:
- Fixed maturity period
- Invested in fixed income securities
- More suitable for short term goals.
- Easy liquidity
Debt funds are very important to balance one’s portfolio. If a person is very conservative and doesn’t want to take any risk with his money, he can go for debt funds. Even though people find it the safest investment, there is still a chance of risk, if the interest rates go up. The chances of such risks occurring is very low.
Another benefit is that, if a person holds the debt fund for more than 3 years, his debt fund will be considered as long term and he will be taxed 20% after indexation. Indexation takes inflation into account and thus reduces the tax on capital gains. TDS is also not deducted on the gains.
Debt has 2 types of funds, open ended and closed ended funds. Open ended funds are those funds which can be sold or repurchased throughout the year. Some of these funds are short term funds, gilt funds, MIPs, etc. For open ended funds, there is no entry load but there can be an exit load, if the funds are withdrawn within a specific period. Now coming to close ended funds, these funds can be bought only at a specific time, that is during the NFO (New Fund Offer). Once the NFO closes, one cannot invest in it. Closed ended funds are for a specific period of time and the chance of exiting is very low. One can only exit by selling it in the secondary market. The risk factor is low compared to open ended schemes.
It is a big risk to put all your money in an equity fund. A better way to manage your money or rather a safer option to put your lump sum amount, would be in a debt fund. And through STP (Systematic Transfer Plan), you can transfer a certain amount to the equity fund from the debt fund. If a person is close to retirement, he can invest his money in a debt fund, because he cannot take a risk with this goal.
How to choose a debt fund?
Well, there are many factors that need to be considered, while choosing a debt fund:
- Need: The most important factor is to know one’s needs. Duration of the goal has to be known first. Only then can one search accordingly.
- AUM of the Fund House: Fund houses with AUM more than 500 Cr. should be considered. The more the AUM, the less the expenses ratio. There’s more trust in such Fund Houses.
- Exit Load: One should also look at the exit load charges, if they want to exit their money beforehand.
- Past performance: It is also necessary to check the past performance of the fund, though it won’t help to know the future performance, but it helps to know whether the fund is performing consistently or not.
- Asset allocation of the portfolio: It is also important to check where the fund has invested in. So you know which assets you’re comfortable with.
These are the factors to be looked for by a person who has no deep knowledge about debt funds. If they still don’t feel confident about it, it is always advisable to seek a expert’s help.
There are many debt funds in the market. It all depends on one’s need and for how long they want it. Some of the debt funds are as follows:
- Gilt funds: These funds invested in Govt. securities only. It doesn’t have a default risk, but having said this, there is a chance of risk with the interest rates, especially long term gilt funds, which are more risky. In this type of fund, one can look at it as a way to increase capital, instead of capital protection. They should also be willing to take the risk.
- Low Duration funds: These funds are invested in commercial papers, bonds with a maturity of 6-12 months, certificate of deposits, etc. Their performance is mostly stable as the changes in interest rates do not affect them. The returns are higher as compared to liquid funds. People who want to invest their surplus money for 6 – 12 months, can invest in this.
- Fixed Maturity Plan (FMP): They are invested for a fixed period of time, in papers matching their maturity. So, there is no interest rate risk in this case. The interest rates of these funds are very predictable, but not guaranteed. But there is reinvestment risk involved. If people are not sure of the interest rates, they can go for these funds.
- Liquid Funds: They are invested in liquid instruments like, treasury bills, Certificate of Deposits, commercial papers, etc. These funds have stable returns. People can invest in such funds instead of keeping their money in the savings account. These funds are invested for a very short time, like a few days or months.
Apart from these, there are many other funds like Dynamic Funds, Long duration funds, and so on. so if you are a conservative investor and even planning to invest, to get a regular flow of income, debt funds are most suitable to you.
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