Skip to main content

Debt Mutual Funds - Tenure, credit ratings are the key

Indian investors prefer investing in debt products like bank fixed deposits (FDs) for reasons such as guaranteed returns (low interest rate risk) and low probability of default (credit risk). In contrast, debt mutual funds have not yet caught up as an investment avenue, mainly because they do not offer guaranteed returns and are volatile in performance.


However, it is important for investors to understand the key factors responsible for such uncertainty or volatility in the performance of debt mutual funds so that they are better positioned to benefit from these funds:


Debt fund valuations: Impact of credit rating and maturity period (duration)
Debt fund valuations depend on the prices of the underlying portfolios of securities, which may fluctuate either way (like stocks) on a day-today basis depending on market dynamics. Hence, the daily net asset value (NAV) of a debt fund may or may not always move upwards. Fluctuation in prices of debt securities leads to volatility in the NAVs of debt funds.
Valuation of debt securities is dependent on the interest (coupon) paid by the instrument and the expected return (yield) from such securities. Here, coupon is pre-decided, while yield is largely driven by market factors like repo rates, liquidity situation, etc. The coupon paid is dependent on two other variables: Duration of the security and the credit rating of the security.


Investors expect higher coupon from securities that have a longer maturity. This is because uncertainty about interest rates rises as the period gets longer. To compensate for the higher risk, higher coupons are offered for long periods. Further, from a credit rating perspective, a higher rated security would offer a lower coupon and vice versa.


Government-owned (sovereign) securities have no default risk. Hence, for a similar maturity period, such a security would offer a lower coupon compared to a AAA-rated corporate security, which in turn would offer a higher coupon than a AA-rated security.


Inverse relationship


Most investors are unaware of the inverse relationship between price and yield of debt instruments: When the price of a security goes down, the yield on the paper goes up. For example, if one buys a debt instrument with a 10% coupon at a price of Rs 100 per unit, the yield is the same as the coupon, that is 10% (coupon divided by the price).
When the price goes down, to say Rs 90, then the yield rises to 11.11% as the same coupon is now available at a lower price. Conversely, if the price rises to Rs 110, the yield drops to 9.09%, clearly indicating the inverse relationship.


To derive maximum benefit from this relationship, one must be invested in long-term debt funds or instruments when interest rates are expected to fall.


Importantly, long-term securities are more sensitive to interest rate movement than short-term securities. Hence, when interest rates rise, short-term security prices decline less vis-à-vis long-term securities.


Debt fund management largely a play on duration in India


Most Indian debt mutual funds prefer investing in the highest rated securities. However, from a credit perspective, there is a separate breed of funds called credit opportunity funds that try to maximize returns by investing in lower rated securities.


Here, the fund manager's skill is in ascertaining the right securities that have minimal probability of default. However, the true skill of a fund manager lies in the call on duration, in other words the direction of interest rate.


If a fund manager feels that interest rates are going to fall in the near term, he/she would increase the average maturity (duration) of the portfolio and decrease if he/she feels interest rates would rise.


His/her skill in predicting interest rates and creating a portfolio of securities with relevant maturity (long or short) can earn significant returns for the investors.


Some of the best Tax Saving Mutual Funds available ( ELSS Mutual Funds )

  1. ICICI Prudential Tax PlanInvest Online
  2. HDFC TaxSaver Invest Online
  3. DSP BlackRock Tax Saver Fund Invest Online
  4. Reliance Tax Saver (ELSS) Fund Invest Online
  5. Birla Sun Life Tax Relief '96 Invest Online
  6. IDFC Tax Advantage (ELSS) Fund Invest Online
  7. SBI Magnum Tax Gain Scheme 1993 Invest Online
  8. Sundaram Tax Saver Invest Online
  9. Edelweiss ELSS Invest Online

    ----------------------------------------

Happy Investing!!

We can help. Call 0 94 8300 8300 (India)

Leave your comment with mail ID and we will answer them

OR

You can write back to us at PrajnaCapital [at] Gmail [dot] Com

---------------------------------------------

Invest Mutual Funds Online

Transact Mutual Fund Online

Download Mutual Fund Application Forms from all AMCs

Download Mutual Fund Application Forms

Best Performing Mutual Funds

    1. Largecap FundsInvest Online
      1. DSP BlackRock Top 100 Fund
      2. ICICI Prudential Focused Blue Chip Fund
      3. Birla Sun Life Front Line Equity Fund
    2. Large and Midcap FundsInvest Online
      1. ICICI Prudential Dynamic Plan
      2. HDFC Top 200 Fund
      3. UTI Dividend Yield Fund
    1. Mid and SmallCap FundsInvest Online
      1. Reliance Equity Opportunities Fund
      2. DSP BlackRock Small & Midcap Fund
      3. Sundaram Select Midcap
      4. IDFC Premier Equity Fund
    1. Small and MicroCap FundsInvest Online
      1. DSP BlackRock MicroCap Fund
    1. Sector FundsInvest Online
      1. Reliance Banking Fund
      2. Reliance Banking Fund
    1. Gold Mutual Funds Invest Online
      1. Relaince Gold Savings Fund
      2. ICICI Prudential Regular Gold Savings Fund
      3. HDFC Gold Fund

Popular posts from this blog

ULIP Review: ProGrowth Super II

  If you are interested in a death cover that's just big enough, HDFC SL ProGrowth Super II is something worth a try. The beauty is it has something for everybody — you name the risk profile, the category is right up there. But do a SWOT analysis of the basket, and the gloss fades     HDFC SL ProGrowth Super II is a type-II unit-linked insurance plan ( ULIP ). Launched in September 2010, this is a small ticket-size scheme with multiple rider options and adequate death cover. It offers five investment options (funds) — one in each category of large-cap equity, mid-cap equity, balanced, debt and money market fund. COST STRUCTURE: ProGrowth Super II is reasonably priced, with the premium allocation charge lower than most others in the category. However, the scheme's mortality charge is almost 60% that of LIC mortality table for those investing early in life. This charge reduces with age. BENEFITS: Investors can choose a sum assured between 10-40 times the annualised premium...

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...

Section 80CCD

Top SIP Funds Online   Income tax deduction under section 80CCD Under Income Tax, TaxPayers have the benefit of claiming several deductions. Out of the deduction avenues, Section 80CCD provides t axpayer deductions against investments made in specific sector s. Under Section 80CCD, an assessee is eligible to claim deductions against the contributions made to the National Pension Scheme or Atal Pension Yojana. Contributions made by an employer to National Pension Scheme are also eligible for deductions under the provisions of Section 80 CCD. In this article, we will take a look at the primary features of this section, the terms and conditions for claiming deductions, the eligibility to claim such deductions, and some of the commonly asked questions in this regard. There are two parts of Section 80CCD. Subsection 1 of this section refers to tax deductions for all assesses who are central government or state government employees, or self-employed or employed by any other employers. In...

Merger of Tata Indo-Global Infrastructure Fund with Tata Equity Opportunities Fund

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300 Merger of Tata Indo-Global Infrastructure Fund with Tata Equity Opportunities Fund Tata Mutual Fund has decided to merge Tata Indo-Global Infrastructure Fund with Tata Equity Opportunities Fund, with effect from January 16, 2015.   Investors of Tata Indo-Global Infrastructure Fund can redeem/ switch out units from December 13, 2014 to January 12, 2015 without paying any exit load. For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call Leave a missed Call on 94 8300 8300 Leave your comment with mail ID and we will answer them OR You can write back to us at PrajnaCapital [at] Gmail [dot] Com --------------------------------------------- Invest Mutual Funds Online Invest Any Mutual Fund Online Download Mutual Fund Application Forms from all AMCs Download Mutual Any Fund A...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now