Debt Mutual Funds – Know The Risks, Rewards and Common Terms used.
There are 16 categories within Debt Mutual Funds broadly based on the average maturity and credit profile of the debt portfolio. Your choice of Fund will essentially depend on yourinvestment horizon and your risk appetite.
We Know that there are essentially 2 types of risks in Debt Funds-
Duration risk and Credit risk.
Duration risk increases with increase in the duration of the debt portfolio and is a function of the interest rate movements.
Credit risk pertains to the default risk of the debt.
It is important that both these parameters are explained clearly by your MF distributor/advisor. Tax benefits kick in after 3 years of staying invested in a debt fund in the form of long term capital gains tax.
Some common terms you should know :-
Coupon rate: This is simply annual interest payable by the bond
Yield to maturity: Weighted average return of all bonds in the portfolio. We should be aware that An abnormally high YTM may indicate the presence of a low rated paper hence default/credit risk may be high.
Modified duration : Reflects interest rate sensitivity of the NAV to interest rate movement. Higher the MOD, higher the sensitivity. The NAV of a Debt Fund is inversely proportional to interest rate movements.
Rating profile : Do check the rating profile of the debt portfolio. The safest rating is a sovereign one, followed by AAA, AA and so on…the worst being D or default rating. It is essential to check the rating profile of the portfolio before #investing.
Gilt funds: Simply put, Gilt funds invest only in fixed income instruments issued by the government , also commonly called government securities or g-secs. The government bonds used to be issued in golden-edged certificates hence the name. These are the safest debt instruments in terms of credit risk.
Interest Rate cycle: The central bank of every country increases or decreases the key interest rate to control the state of the economy. We generally find interest rates tending upwards, downwards or flat depending on the needs of the economy. It is important to know the current trend of the interest rate movement while considering debt products. A low average maturity portfolio is better during the upward trend of interest rates and vice-versa during a downward ride of the interest rates.
Before investing in #DebtMutualFunds it is essential to understand the risks involved and also check if the fund you are investing in matches with your investment needs and horizon.