Tag Archives: Wealth Adviser

Debt Mutual Funds Simplified

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Greetings from PenguWIN,

I wanted to pen a short and simple write-up on Debt funds. The objective is that the investors should have a basic understanding of what a debt fund is and how it works. 

Debt funds are categorized based on the maturity profile of the instruments/securities/papers (used interchangeably) that they hold. In simple terms you can think of 60 days FD (Fixed Deposit), 91 days FD, 1-year FD and so on. If money is required in about 3 months, it is invested in a 91 days FD and if it is required in 13 months, it is invested in 1 Year FD. Similarly, depending on the tenure, investments in debt funds start from Overnight funds (few days), Liquid funds (weeks to a few months), Ultra-Short Duration funds (more than 3 months), going up to Long term, and Gilt funds. 


Debt funds comprise of instruments of multiple attributes – interest rate, company, rating, and tenure. Instruments over 1 year are long-term and rated as “AAA”, “AA+”, “AA” and so on. Instruments less than a year are rated as “A1+”, “A1” and so on (Crisil’s Rating Scale). Government issues long-term securities, referred to as GSECS and short-term securities, less than a year maturity, referred to as Treasury bills. GSECS and T-bills are also instruments (sovereign and backed by Government of India) that debt mutual funds invest in. 


The difference between a Bank FD and a Debt fund is that FDs are linear products (no volatility). But, if an investment is made in a 1-year FD for 6% and broken in 6 months, the interest rate will probably be around 4%, which is the rate for 6 months and there could be an additional penalty too. However, if an investment is made in a short-term debt fund, say Ultra-Short-term fund for 1 year which is expected to provide a return of 6%, typically, it will stabilize in a month (even less in many cases) and even if an investor exits in say, 2 months, the return will be about 6% (on an annualized basis). The returns will not be linear but close to linear (say, 5.5% in week 1, 6.2% in week 2, 5.8% in week 3, and so on) which provides a huge advantage of investing short-term money that might be required anytime. If an investor remains invested for 3 years, tax benefits through indexation kick in, which is very significant, and FDs do not get this benefit. Debt Funds do not have tax deduction at source (TDS) which means there will not be annual taxes to be paid. It needs to be paid only when the fund is redeemed. FDs have TDS which means compounding effect will be reduced.


Unlike FDs, fund managers trade securities in their schemes, purchase when money comes into the fund (investments), and sell (redeem) when money is required by investors. The volatility of returns from Debt funds is considerably low but not “Zero‘ and that’s why debt fund returns are close to linear but not perfectly linear. So, debt funds NAV (Total value of fund/ Number of outstanding units) increases slowly. Only during extreme situations, there would be wide swings in the NAV as a result of changes in the ^yields of underlying instruments. 


Typically, if a scheme/fund has invested in a proportionately high number of “AAA” papers, “A1+”, GSECs, the risk level is lower and so will be the returns (AAA yield will be lesser than AA, AA less than A+ and so on). To increase the fund returns, fund managers invest in less than AAA, say “AA-“ type of instruments. If a fund has 50 instruments, 10 maybe AAA, 15 in A1+ and rest in AA and AA-. Also, securities that are AA need not be of low quality. Ex. Airtel’s 8.25% Non-Convertible Debentures (NCD) is rated “AA” and knowing the pedigree of the company why would anyone hesitate to invest? If the question is, then why is it not rated “AAA”, it is beyond the scope of this write-up and requires an explanation of the credit rating process.

Daily, depending on the transactions done, the instrument gets a value like AAA, 3 years is 6.75, 5 years is 7.2, and so on. The price of the security goes up and down as it gets traded, based on demand and supply. Since the interest rate is constant like 8.25% in the case of Airtel NCD, it’s the yield that varies periodically.


^Yield is the return that you would get for the current price of the security. If Airtel 8.25% NCD has a lot of demand, then the price of 1 unit of the bond, say 1000 Rs. will increase to 1100 but the interest rate remains the same 8.25%. In this case, the yield would be 8.25% of 1100 or 7.5% i.e. Yield decreases as price increases and increases as price decreases (inversely proportional). Yield is the reference and key parameter for a security/instrument like the current market price of a share (Reliance Industries stock price is Rs. 1400/- (current trading price) and the face value of Rs. 10/- loses its significance.


When there is liquidity squeeze in the market i.e. demand for instruments by buyers goes down than supply or sellers trying to sell too many instruments, the price of the instrument/bond goes down and the yield shoots up. In such a scenario when a fund manager tries to sell lesser quality papers (AA, A+) the takers will be lesser resulting in a distress sale. If the value of a bond (Rs. 1000 face value) goes down to say 800, then the Net Asset Value (NAV) goes down sharply and this is what happened to the 6 Franklin Debt Funds which were in the news, recently. There could be a situation where there are no takers at all and price discovery itself becomes a challenge. If a distress sale happens then there will be a huge erosion of NAV, severely affecting the interests of investors. The underlying instruments (say even “AA”) can still be good and companies might pay back the loan in time. The current crisis is more of a demand-supply mismatch rather than the credit quality of the instruments. All other factors remaining the same, the quality of papers like AAA Vs AA might matter. But, Franklin has been managing the funds in this fashion for over a decade without any issues, investing in lower credit quality instruments, and providing substantial additional returns to its investors. 


Leave no stone unturned to help your clients realize maximum profits from their investment - Arthur C. Nielsen

<Blog # PenguWIN 1076 – Debt Mutual Funds Simplified>

Budget 2020

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POV 1 – Propensity to Spend

Experts were of the opinion that the demand slowdown can be countered by putting more money in the hands of the consumers, so that they can spend. The expectation was that the budget will cut taxes. The budget team came up with the innovative solution of cutting the taxes for consumers, if the deductions can be foregone. The savings rate that was already on a downward spiral, as the young consumers wanted to enjoy today rather than save, will be further accentuated. Whatever little savings that the young folks were doing by investing in NPS, ELSS, PPF et.al. to save on taxes will also go for a toss.

Retirement Planning

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Greetings from PenguWIN

Across the globe, including US, Germany, UK and India, surveys conducted among retired people, have revealed one common response – “We should have saved more for retirement”

Retirement is one of the most critical financial goals that needs a corpus (sum of money) to be built, for a period of time (like 25 years from age of 55), adjusted for inflation (money value going down). In rupee terms, a person who is 35 years old today, planning to retire by the age of 55 (2039), needing 50,000/- per month in today’s value, at an inflation rate of 6%, would need a sum of approx. Rs.1,60,000/- per month in 20 years or 3.21 times of what is required today. If he earns a return of 7% after taxes and the inflation rate continues to be 6%, his retirement fund needs to be Rs. 4.28 crores by 2039 (retirement year), assuming he lives till the age of 80 years (2064). i.e. 25 years post retirement age. This value would be higher if he lives for more than 80 years.

Hence, a contingency need to be built so that he does not outlive the corpus. On the contrary, if he lives lesser than 80 years, the wealth can be passed on his beneficiaries.

Retirement Planning has the potential to become an enormous problem for Indians, with increasing life expectancy. People are diagnosed with lifestyle ailments including Diabetes, Blood Pressure, Cardio problems at an early age. However, they would continue to live long due to advancements in the field of medicine which means increasing health care costs. Unlike western countries where hospitalization and prescription medicines are covered, health insurers in India cover only hospitalization and regular medication including insulin, tablets, regular tests need to be borne by us. On the other hand, the retirement age is declining in private sector with availability of young talent pool resulting in people getting relieved of their services by age of 50-55 and is expected to decrease further, in future. Essentially, this means that one needs to accumulate a substantial corpus in 20+ years of their active earning life which should help sustain for 25+ years.

Government servants who joined service before 1 Jan 2004 were fortunate enough to be eligible for pension, that is adjusted for inflation. For the rest, retirement planning has to be done meticulously (including the Govt. servants for whom the pension may not be sufficient) so that they can lead an independent life with esteem and not dependant on their children or relatives or friends.

While the retirement corpus number might look daunting, please remember that these are numbers for future and adjusted for inflation. To quote an example, I remember having a plate of Idly in Saravanan Bhavan for about 2 to 3 rupees in late 80’s and if I were told that the same would cost about 40 Rs. in 2019, I would have had an extra plate then thinking that I can afford 3 more rupees and may not be able to afford that high a price in 2019.  But today we continue to consume Idlis paying 40 rupees.

Given the variety of products that are available in the market including Bank and Postal FDs, Senior Citizen Savings Scheme, Post Office Monthly income Scheme, RBI bonds, Corporate FDs, Non-Convertible Debentures (NCDs), Public Provident Fund, Employee Provident Fund, National Pension System, Annuity, Mutual Funds, Direct Equity Investments, it is very much possible to plan and build a portfolio for retirement. It’s just that the planning and accumulation process has to start as early as possible where the money to invest on a periodic basis would be less than try to start late in the game when the monthly investment requirement would be significantly higher.

Most investors want to do today what they should have done yesterday.  - Larry Summers 

<Blog # PenguWIN 1071 – Retirement Planning>