How to pick the right debt fund

Given that people devote much more time and effort to picking equity funds than debt funds, one would think it's easy to choose the latter. On the contrary, selecting a debt fund is more problematic because of the large number of categories available-liquid, income, short-term, ultra short-term, gilt, monthly income plans, fixed maturity plans, etc. Though the selection of a fund requires the same basic criteria-risk profile, consistency in performance and fund manager's track record-across all categories, there are other factors that need to be examined while investing in a debt fund. Let us examine some of these.

Time horizon and fund maturity

As a debt fund investor, you should first ascertain the period for which you want to stay invested. This is because the maturity profile for each category is different. Ideally, you should match the time horizon for your investment with that of the fund. Says Umesh Sharma, vice-president and portfolio manager, fixed income, Franklin Templeton Investments India: "People should look at investing in fixed income funds that are in sync with their investment horizon and risk profile."

So, if you are looking at an investment horizon of, say, three months, don't invest in liquid funds. Instead, opt for ultra short-term funds, where the average maturity of the underlying paper is up to 90 days. For those wanting to stay invested for a year or more, income funds or fixed maturity plans are the best option. Also, keep in mind that short-term gains in debt funds are taxed according to the applicable tax slabs, whereas long-term gains are eligible for the inflation indexation benefit.

Quality of underlying paper

The quality of debt instruments in the fund's portfolio should be scrutinised closely. Each instrument is assigned a credit rating that signifies the level of default risk. The higher the rating, the safer the instrument. To check this, investors can go through the offer document as well as the subsequent fact sheets published by the mutual fund. A debt fund may invest in several instruments, ranging from risk-free government securities to high-risk corporate paper.

A fund holding large amounts in a poor quality paper may find it difficult to sell such securities in the market, thereby putting your money at risk. While a debt fund with a risky paper is likely to yield higher returns, it may work unfavourably for the investor. As the safety of capital is of utmost importance to a debt investor, one should not go for funds with low quality investments. Killol Pandya, head of fixed income at Daiwa Mutual Fund, agrees that investors should choose debt funds with better asset quality. He says, "Debt funds are inherently geared towards protecting capital and providing stable returns over reasonable periods of time while keeping risk under manageable levels. So the investor must always keep in mind the risk profile of the debt fund."

Source: Economic Times

Thanks and Regards,
Sanchari Sinha,
Intern at DENIP Consultants Pvt. Ltd.