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Friday, January 15, 2016

Debt Funds Risks – Interest Rate Hike and Liquidity Risk

 

Debt Fund Risks

It's a myth that – debt schemes have very less risk associated with them but investors should be aware of fluctuations in interest rate and accordingly work on planning the financials and choose appropriate asset allocation. A debt fund faces three kinds of risks and how it manages them determines your returns.

Interest Rate Risk: While debt funds invest in instruments that give fixed income, their actual returns can fluctuate. The kicker in returns comes from capital gains, the basis of which is the inverse relationship between interest rate and bond prices. In case of any interest rate hike, returns offered by debt schemes go down and there is also a possibility of returns going negative.

Default Risk: All government debt is guaranted by the exchequer and there's no risk of its defaulting. But corporate debt doesn't come with such assurances. A company's ability to service its debt depends on its financial health. An ailing company can default on its payments and hurt investors.

Liquidity Risk: Stocks are actively traded while government securities and treasury bills record good trading volumes. However, the corporate bond market generally faces serious liquidity issues. Trading is confined mostly to high-rated bonds.

Risks associated with long term debt funds: These funds invest your money in corporate papers which are always in the danger of credit risk especially the realty sectors.

Recommended For:

  1. Long term investors.
  2. Investors with lower risk appetite.
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