INVESTORS constantly look for alternative avenues to complete their investment requirements. Debt is one area where there is a lot of action as a significant portion of investors' portfolios is invested in this asset class. A number of options are available in this segment. One of these is debt mutual fund.
There are several factors that distinguish this product from other debt instruments.
Nature of risk:
One major factor that differentiates a debt fund from other debt instruments is the nature of risk. A normal debt investment that most people are comfortable with, such as bank fixed deposits or other small savings options, will have a fixed rate of interest and a fixed tenure for which the investment will be held.
But when one invests in an open-ended debt scheme, the situation changes, as there is no compulsory end period to the investment and returns earned will not be fixed in nature. The call on the tenure of investment is entirely investor's in this case. One needs to ensure that the decision on this aspect is taken considering various factors affecting them.
There is a new risk in this kind of investment, not present in traditional debt products, the interest rate risk. It arises from the fact that there can be a movement in interest rates against the expectation of a fund manager.
There are also other risks, such as credit risk, which arises if the fund is unable to recover the money invested in a particular instrument.
There is also a risk that earnings can be less than inflation, which may leave the investor with lesser purchasing power.
Volatility:
With the recent regulatory changes, there is another risk of higher volatility (than what is seen at present). This can be the case with short-term debt oriented funds. This will occur as these funds will now require to mark to market all money market and debt securities with a maturity period of over 90 days.
This means a large majority of short-term debt funds may have a large percentage of their portfolios marked to market. However, it's important to take note of two things at this stage.
Ø One is that volatility in debt funds will always be far less compared with equity funds.
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Secondly, funds can choose to have very short-term instruments in their portfolios, but this will be at the cost of returns. This kind of a portfolio will also not be suitable for all funds.
Most investors equate a debt investment with stability and it is often a tough task to get them to understand that unlike traditional debt instruments, debt funds can see a rise or fall in their net asset values (NAV).
Time matters:
There are several ways to tackle an increased volatility in a debt fund. One of them is related to the time period available for investment. The moment there is mark to market for the portfolio of a fund, some amount of volatility is bound to creep in. One option is to go for those funds that do not have such a portfolio, and this will have lesser volatility. The other way the impact of this factor can be reduced is by attuning the portfolio to a specific time period.
For example, if your investment horizon is 15 days, you can choose a liquid scheme to invest you money.
If the investment horizon is six months, you will need to select a fund that has a portfolio matching this duration.
This will result in a situation where the former will give lower returns and the latter will still retain some volatility. But it will at least eliminate the worry of any mismatch with the investment process. On the other hand, matching a 15-day investment requirement with another type of fund can be a disaster as during this time if the interest rate movement is against the fund, it could lead to a loss of capital.
Impact on returns:
Problems may also arise when an investor is caught on the wrong foot in a debt fund investment. This happens when a sudden change leads to a fall in performance.
The option here is to evaluate an investment to see whether a recent impact was a one-time problem and if it can have any impact on the performance in future. If the investment is expected to do well as the situation improves or the condition that led to the impact reverses, then the wise thing to do will be to continue with the investment. At the same time, if it appears that it will take a long time to recover from the hit, then it may be a better idea to exit the investment and look for better opportunities elsewhere.
