How to avoid debt fund mishaps while investing in Mutual investment.

The last couple of years have been turbulent for Indian debt funds, with a series of defaults and downgrades. However, the critical role that these funds play in one’s portfolio can’t be ignored. Debt funds are crucial for portfolio diversification, offering high liquidity along with tax benefits on long-term capital gains.

Hence despite the current investment climate, one must not write off fixed income instruments. Instead, here’s how you can avoid making mistakes when investing in this asset class.

Know Your Fund Manager:

Debt funds invest in fixed income instruments such as government rated bonds, treasury bills and short-term papers, among others. Their objective is to generate modest to high returns that can cushion your portfolio when capital markets seem volatile or uncertain.In the case of debt funds, fund managers need to tackle two vital risks associated with this category of mutual funds – credit and interest. While the former arises due to the inability of the issuer of the security to pay back the principal, the latter crops from the decline in value, due to change in interest rates.

Hence, before investing in a debt fund, analyse the fund manager’s track record to better understand how he has tackled these two risks in his tenure.

Analyse the AMC’s investment model

In a bid to chase high returns from debt funds, some AMCs often bet on high-risk securities. However, this can prove detrimental in the long run. It’s in your best interest to avoid funds from AMCs that invest in such high-risk securities for extra gains.As mentioned earlier, the objective of debt funds is to provide diversification to your portfolio and mitigate any expected erosion of accumulated gains because of market fluctuations. It is not to generate high returns. While it can be difficult for you to gauge the risk of underlying debt fund securities, seeking professional help can help you make an informed choice.

Opt for debt funds which invest in securities of lower duration:

Post a recent regulatory rejig by SEBI, we have 16 categories of debt funds which invest in securities with different duration for maturity. Higher the duration, greater are the risks and chances of mishaps. Hence, you should opt for debt funds which invest in securities with a lower duration such as overnight and liquid funds. While overnight funds invest in securities maturing the next day, liquid funds invest in securities with a maturity period of 91 days.

View portfolio concentration:

This is another important aspect to be considered to avoid any mishaps when investing in debt funds. The fund you choose should not overexpose itself to securities of any single company or group of companies.

Do note that in some cases, securities of the same company can be named differently. So choose funds that have a higher distribution of securities from different companies, across varied sectors, which will effectively lower any chances of default.

The final word:

(By Rahul Jain, Head-Personal Wealth Advisory, Edelweiss):

Before investing in a debt fund scheme, check out its long-term performance and see how it has performed in the bearish phase. Researching and arming yourself with the right knowledge can help you bet on debt funds safely.

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