Before
making any investment decision, investors must be careful and only consider
schemes that are ideal for their investment goals. In most cases, people end up
investing in the same schemes as their peers and usually end up losing their
money. That’s because every individual has different goals, investment
horizons, and risk appetite. Replicating others’ financial planning is not a
healthy way of investing and it is always better to set realistic and
achievable goals. Investors often consider debt mutual funds for
diversification. Debt mutual funds predominantly invest in equity and equity-related instruments to generate stable returns. They are considered to be less
volatile than equity funds but carry interest rate risk, credit rate risk, and
liquidity risk.
So,
if you are planning on investing in a liquid fund or a gilt fund, these are the
key parameters that you need to know before investing in debt funds:
Check
for the portfolio’s average maturity
Every
debt mutual fund portfolio has an average maturity that may vary from scheme to
scheme. Depending on the scheme’s nature and its investment objective, a debt mutual
fund may invest across securities like commercial papers, government
bonds, treasury bills, certificates of deposits, etc. Each of these security has
a different maturity period. Investors can find the average maturity of a debt
fund in its factsheet. Some funds like ultra short-term funds and liquid funds
have a shorter maturity and hence are ideal for investors who want to park
their money for a very short period. On the other hand, debt funds like gilt funds
and long-duration funds have a longer average portfolio maturity and are ideal
for investors who wish to remain invested for the long haul. Hence, investors
should understand the average portfolio maturity of a debt mutual fund before
investing.
Interest
rate sensitivity
Fluctuations
in the interest rate can affect the performance of your debt fund. However,
certain schemes may remain unaffected by interest rate fluctuations. Debt
mutual funds with a longer portfolio maturity have a very high-interest rate
risk. This may also impact their NAV as opposed to debt schemes with a shorter
average portfolio maturity. Since the underlying securities of such schemes
mature in a short span of time, their NAV is less likely to face any interest
rate risk.
Macaulay
Duration
If
you have done some research about debt schemes you must have come across the
term ‘Macaulay Duration’ in the fund’s investment objective section. For those
who aren’t aware, Macaulay duration is the is the time or duration after which
the investor is likely to recover the principal amount that they invested in a
debt scheme. Debt funds with a Macaulay duration of 1 to 3 years take short
time to recover the principal sum and vice versa.
Credit
rate risk
Although debt mutual funds try to generate stable returns by investing in top rated debt securities, there are certain funds that invest in securities that have AAA below ratings. Such schemes have a high credit rate risk because if the issuer is unable to repay the loan within the stipulated period, this can affect the performance of your portfolio. However, debt funds that invest in riskier debt instruments have the potential to generate higher returns. Investors, depending on their risk appetite should consider investing in a debt scheme that is ideal for their goals.
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