Asked about details of his debt mutual fund holdings by a financial advisor, the young executive was shocked. “When I put my money in a bank, I never worry about what the bank does with it. I am happy as long as I get my interest”, was his terse response. Well, the investor has got it wrong for two reasons. Firstly, a debt mutual fund is not like a bank FD because there is no assured and fixed returns on the debt fund. It is entirely dependent on the performance of the fund. Secondly, the investor needs to understand even a debt fund in granular detail as many of the smaller factors can have a huge impact on the fund performance.
Like in case of an equity fund, the fund fact sheet also provides a wealth of information in case of a debt fund.Normally, every fund house gives a consolidated fund fact sheet and you will have to identify your fund from the elaborate list. Here are 4 basic factors that you need to look into when you evaluate the performance of your debt fund.While debt funds can be short term, long term or liquid, we shall keep our focus on long term debt funds.
Yes,you need to get the basics right here too..
Of course, debt fund is also about performance.Normally, debt funds will not make a huge difference if you compare across time frames. For example, the performance of a debt fund over a 5 year period and a7 year period will not be substantially different. Unlike equity funds, the peer group differences in debt funds will also be much lower. Secondly, look at the expense ratio. Remember, returns on debt fund tend to be lower than on equity funds and therefore the expense ratio matters a lot. The fund fact sheet also provides a comparison of normal debt fund plans and direct plans. Indirect plans you save the brokerage and you need to take a conscious call after evaluating the difference n returns.
Portfolio quality is of utmost importance in case of debt funds..
Most debt funds will predominantly invest in sovereign bonds or G-Secs as they are popularly known. However, every fund will be searching for alpha and that will compel them to add a mixture of private corporate bonds and even lower rated bonds. This is where you have to exercise caution. The exposure to any particular group must be ideally below the maximum limit permitted by SEBI. You need to additionally careful if the particular debt is below “AAA” grade and if the group is currently going through financial stress. The recent list of NCLT companies is a case in point. We have seen how exposure to bonds of Amtek Auto and RCOM in the past have resulted in huge losses for debt fund investors when the rating agencies sharply downgraded these bonds
The corpus of the fund is very important..
When you are putting money in a debt fund you need to be focused on the AUM of the particular fund and the AUM of the group on the debt side. This is of specific importance for debt funds as size matters a lot when it comes to getting competitive bids in the treasury market. One of the reasons the SBI treasury earns higher returns is due to their size which gives them tremendous clout. A bigger AUM and a larger AMC group will go a long way in ensuring better market clout. At least, when it comes to debt funds try to avoid the smaller funs with limited AUM at their disposal.
Finally,the most important aspect of Maturity and Duration..
Firstly you need remember that maturity and duration are two entirely different concepts. When we talk of maturity we refer to the term to maturity or the residual term to maturity. For example, a 10year bond issued in 2015 will have an average residual maturity of 8 years in2017. Duration is much more complex. It is the weighted maturity of the bond based on the cash inflows in the form of interest and redemption. Since interest payment on bonds begins from year 1, all bonds will have duration that is less than maturity. The only exception is a deep-discount bond which will have similar maturity and duration due to no intermediate cash flows. While maturity tells you about the nature of the fund, it is duration that has practical applications. There are 2 key implications..
Firstly, duration is a measure of the impact of the shifts in yields on the market price of the bond. We know that when rates in the market go down, the bond price goes up and when rates go up the bond prices come down. But these movements have a degree that is determined by duration. When the rates are cut, bonds with longer duration will appreciate more than bonds with shorter duration. Therefore, if your bet is on rates coming down then you need to own funds with longer duration and if you expect rates to go up then you must hold debt funds with shorter duration. The second application is with respect to mismatch risk. You normally invest in a debt fund to take care of a liability at a future date. That is where matching comes in handy. When you have a liability to be defrayed at the end of 5 years, then you must choose a fund with duration of 5 years and not a fund with an average maturity of 5 years. That will ensure that there is no risk of maturity mismatch between your debt fund holdings and your liability at the end of 5years.
Remember, a little bit of basic understanding can go a long way in helping you zero in on the right debt funds. Don't just leave it to somebody else to take decisions on your behalf!
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