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Key Parameters you need to know for selecting debt funds

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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