Friends,
Many investors carry a wrong notion that Mutual Funds is all about Equity/Stock investing. But the reality is as on 30th Sep 2016, data from AMFI (Association of Mutual Funds in India) says investments in Equity MFs is 5 Lakh Crores Vs 11 Lakh Crores. i.e. Only 31% of the funds are invested in Equity and the rest 69% are in Debt Funds. Since the content required for this blog is high, I have split it as Part I and II and once I is read, interested readers can look for more details in Part II.
In Financial parlance, Debt is an amount of money borrowed by one party from another, under the condition that it is to be paid back at a later date, usually with interest.
The common debt products that we are aware of are Bank Deposits, Postal Deposits, Tax Free Bonds, Capital Gains Bonds, Sovereign Gold Bonds, Company deposits (Shriram, HDFC). Even our monthly Employee provident Fund (EPF), Public Provident Fund (PPF), National Pension Scheme (NPS), Senior Citizens Deposits are all Debt products. Some of the above products are sovereign debt, which means that the Government stands guarantee and there is no question of losing money.
Since mid-2015, the interest rates offered by banks have been steadily falling and in July 2015, SBI Fixed deposit breached the 8% interest level and moved below. Interest rates are a function of demand and supply for credit and the RBI Interest rate (Repo) has been falling down (currently 6.25%). The RBI had a mandate to tame inflation which worked as Consumer Price Inflation (CPI) fell to 5%. As a result of this the interest rate offered by Bank and Postal Deposits went down.
Before I dwell into Risk Vs Returns of Debt Mutual Funds, I wanted to clarify a couple of points.
Bank Fixed Deposits are Riskier when compared to Sovereign instruments (PPF, KVP, GSec.).
Company deposits (HDFC, Shriram, Bajaj Finance etc.) are Riskier when compared to Bank Deposits.
The chances that any Scheduled commercial bank (Public Sector, Private and Foreign Banks) will go bust in India is extremely low. There were cases like Global Trust Bank which was affected a decade ago, but the government intervened and Oriental Bank of Commerce acquired GTB
Similarly Deposits of companies like HDFC, Shriram, Bajaj Finance, DHFL are “AAA” rated by rating agencies which gives comfort to the investor. ‘HDFC’ brand is so powerful and some investors are happy investing in HDFC deposits (which is used by them for housing finance) rather than relatively less known banks like Catholic Syrian.
As an alternative to the Bank, Postal and Company deposits is where Debt Mutual Funds come in. Debt Funds offer a large category of products, with varying risk and return levels, providing flexibility, incremental returns and favourable tax treatment. They are categorised under different tenure (few days, months, years), Accrual and Duration funds, Liquid, Ultra Short Term, Short Term, Long Term, Income Funds, Gilt funds (Funds that hold Government Securities and also referred as duration funds).
When we are willing to take a small amount of risk in the traditional products for incremental returns, the same applies to debt mutual funds. Again, the point to consider is diversification and asset allocation. It does not make sense to invest all the debt allocation in MFs and we do need the stability of Sovereign products, Bank and Postal deposits. Allocation to MFs will provide the additional kicker to increase the overall debt portfolio returns.
For the next level of insight into Debt Mutual Funds please click the link below:
Opportunity in Debt Mutual Funds – II
<Blog # PenguWIN 1044 – Opportunity in Debt Mutual Funds – I>