Dear Readers,

Debts funds are considered to be one of the safest investment avenues for risk averse investors, or for investments which are meant for short term duration.

However there are certain myths surrounding Investments in debt funds. Let us try to understand these and see how they function in reality.

Before we begin, let us understand what Debt funds are and how they function:

Debt Mutual Funds are the Mutual Funds which invest mainly in a mix of Debt and Fixed Income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. The returns from Debt Fund investments can be in the form of Interest earned and appreciation/ depreciation in capital based on market dynamics.

Despite growing investor awareness and popularity of mutual funds in India, investors are still not fully aware of the Debt markets and how they function. Let us understand some of the myths surrounding them and understand the real picture along with.

1. Debt Mutual Funds provide low returns: Debt Mutual Funds invest in Government Securities (G-Secs) and Non-Convertible Debentures (NCD). They also invest in money market instruments like Commercial Papers, Certificate of Deposits and Treasury Bills etc. These are fixed income bearing securities and provide returns better than a regular Bank FDs. One may claim the returns as compared to Equity funds are low, however, Equities come with their own risks and higher risks brings higher rewards. Debt Funds, provide decent returns and also minimizes the impact of tax on gains at the time of redemption.

2. Bank FDs have higher returns and are risk free (Compared to Debt Funds): Investors consider Bank Fds to be extremely safe, however, Fds are considered safe only to the extent of Rs. 1 Lakh. Also, bank Fds always have the risk of lower interest. If we look at the history of bank FD rates of different tenors, we will see that the bank FD rates were almost always lower than Government bond yields of similar tenors. Thus, one cannot claim Bank Fds to be completely risk free.

3. The Tax impact on Debt funds is high: Though it seems that long term capital gains from Debt funds are taxed @20%, we should not ignore the Indexation benefit one gets on capital invested. The ultimate impact on tax would be approx. 10% of gains after taking indexation into consideration. Also, the short term gains (gains on redemption of debt funds within 3 years of investments) are taxed to the assesse based on their income tax slab.

4. Debt mutual funds are meant for institutional and corporate investors not retail: Debt funds are as efficient for retail investors as they are for Institutional investors. Even though institutional investors account for the vast majority of debt mutual fund assets under management (AUM) in the industry, it also means that there is lack of awareness amongst retail investors regarding Debt funds. Institutional investors want to deploy their funds as efficiently as possible – should not retail investors aspire to do the same? In fact, the considerations which drive institutional investments in debt mutual funds, i.e. liquidity, risk, higher profits and tax efficiency should be the same for retail investors who seek fixed income and are risk averse.

5. All Debt funds are the same: Debt funds are highly diversified in its own category. Debt funds are subject to two kinds of risk- Credit risk and Interest risk. Different categories of debt mutual funds, depending on the nature of underlying securities have very different sensitivities to these risks. Long term debt funds and Dynamic Bond funds are subject to Interest Rate changes. Debt Mutual funds which invest in G-Secs or Gilt Bonds (Government Bonds) are subject to low credit risk. On the contrary, corporate bond funds are subject to credit risk. Thus an investor should understand the risk they are exposed to and then make investment choices.

Let us look at past 5 year performance of top performing Debt Funds:

Thus, if we see, long term returns in Debt Funds have always been decent. Also, one should not judge the Debt Funds on the basis of 1 year performance, they should invest for long term to reap good investment benefits.

  To know more on investments in Debt Funds, feel free to contact us.

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