Looking to invest in debt funds? Here’s what you need to look at before parting with your money
Why is it that only an event makes an investor spend time to review the decision. Ideally, one should look at investments in line with one’s Investment Policy Statement (IPS) and invest proactive. (Source: Reuters)
Why is it that only an event makes an investor spend time to review the decision. Ideally, one should look at investments in line with one’s Investment Policy Statement (IPS) and invest proactive, rather than reactive. But then, every few months, a can of worms opens up. Earlier, it was the downgrade in the debt paper of an auto company in August 2015, which eventually led to the sale of the particular AMC in 2016. Even earlier in 2008, an AMC which had over 85% of its corpus in debt funds was sold at very low valuations because of the drawdown in the credit papers.
Even debt is risky
The perception which runs in the investing community is that equity is risky and debt has no risk or little risk. But then what will you say when investment in the so called safe ‘debt’ products wipes out the gains recorded over a period of one year in a single day.
As an investor, it is very important for you to know the quality of the paper in the debt portfolio. Also its important that you know the investment horizon you are looking at. Tax breaks and capital gain should not be only consideration, while making the investments.
Investors often ignore the credit risk in a debt fund. Credit risk happens if the company issuing the paper is not able to service its debt or pay back the principal on due date or if the credit rating agency downgrades the paper issued by the company. Over the last three months, the 10-year G-sec has moved form 6.2% to 6.9%. This has eroded the returns of medium-and long-term gilt funds. Most of the investors have not noticed this in the portfolio.
Even though RBI has maintained the status quo, the debt markets are saying a different story.
This is the interest rate risk, wherein the any change in the interest rate has an impact on the portfolio return. In this case, the prices of the older instruments has fallen as the newer instruments are priced higher.
Active management of debt portfolio is required in the medium-and long-term debt instruments. To manage the portfolio, maturity along with liquidity is a job for the active debt fund manager. This can at times lead to volatility even in the debt investments.
You might also want to see this:
Reinvestment risk is another ignored risk while investing in debt products. Bank fixed deposit rates which used to be at 9% two years ago is today between 5.5% and 6.5%. Here the economic undercurrent is what has changed and not credit risk or interest rate risk.
As an investor, you need to know the credit quality, portfolio maturity, liquidity in the portfolio, and also whether the fund is sticking to its core philosophy. A liquid-plus fund having debt paper of duration over 6 months is a cause of concern. It is not advisable to chasing returns in debt funds.
The writer is partner, BellWether Advisors LLP