Selecting a Debt Mutual Fund is unexpectedly more complicated than opting for a diversified equity fund. Even in the case of seasoned investors, understanding and tracking of interest rate movements and the credit risks are exclusively challenging. Yet this is one happiest hunting category for all the corporate treasuries, high-net-worth folks and institutional investors. Again, retail investors or the beginners, generally feel lost when it comes to selecting the right debt mutual fund. But here, with our essential tips, you will get the opportunity to choose the right path!
- Know the investment horizon
Investment in the debt equity funds is made for long duration. Although, it is also classified and categorized differently over the basis of risk appetite of the investor. Getting more specific, they are suitably based over the investment horizon. There are various types of debt funds which are available for unique investment horizons. They include-
- Liquid funds: which are held for duration of 0-3 months
- Ultra short term funds: their term is of 3 months – 1 year
- Short Term funds: you can invest in them for 1 – 3 years
- Intermediate/Long Term funds: they are meant for the ones, willing to invest in More than 3 years
- Explore about the Interest Rate Risk
There are two essential investment strategies which affect your decision of investing in the debt mutual funds. The strategies depict the interest rate and their relations with the investment that might affect the lives of debt fund managers. These are-
- Duration- interest rates and debt fund returns share an inverse relationship. The debt fund returns will jump up, if the interest rate goes down. Thus, here the fund managers adopt a duration strategy of investing in long term bonds so as to get benefitted from any such falls in the interest rates. As the interest rate risk is quite high in such funds, the investors might lose a lot of capital when the interest rate goes high. Thus, surely, this is the only strategy to tackle such problems.
- Accrual- under this strategy, the investors deposit their hard earnings in the short term instruments as here, the risk rate is perhaps lower. Your securities here are held till maturity and reduce the risk of interest rate more prominently. As they are safer, they are eventually less volatile when it comes to returns.
- Dynamic bond funds- in the case of these funds, the investor may end up depositing across various instruments of differentiated time horizons. The fund manger here takes up a view over interest rates and turns out with the deposit decisions accordingly. Also, the risk levels here fall somewhere between the risks associated with accrual and duration strategy. To deal with these funds, the fund manager must be experienced with a positive track record.
- Don't fall for exceptionally High Return
If you encounter certain fund with enormously high returns, as compared to its companions, then go through a reality check of where these returns are coming from. The debt instrument gets assigned with a credit rating and this, depicts how safe your instrument is. The ones with lower credit ratings provide higher returns and compensates for their lower ratings. Thus, before you invest in any fund with higher pay outs go through its portfolio and check out whether it's over exposed or not. If it carries extremely poor ratings, the liquidity risk will make it tougher for you to resell the instrument.
- Step- 4Have a look on the fund size
The fund size is an essential factor in debt funds as liquidity is lower in the debt markets. The fund performance here might get affected in a condition where fund size is small and there are substantial redemption requests. However, on the other side, the well sized debt fund would bring in sufficient alternatives to the fund manager if the substantial redemption requests are still there.
There are many steps & factors that need to be taken care. So, it would best to consult your financial Advisor.