Introduction
Debt funds are investment funds that primarily invest in fixed-income securities such as corporate bonds, government bonds, money market instruments, and other debt securities. The primary objective of debt funds is to generate regular income for investors while minimizing risk.
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Debt funds are managed by professional fund managers who use their expertise to identify the best fixed-income securities to invest in based on factors such as creditworthiness, yield, and maturity. Unlike equity funds, which invest in stocks, debt funds offer lower risks and are ideal for conservative investors who are looking for stable returns.
Debt instruments are of two types short term and long term. Both are issued by government and corporates. For example treasury bills, commercial paper, certificate of deposit, Repo and reverse repo. Some are issued by private sector known as bonds- also known as Debentures.
Debt funds are available in various categories, including liquid funds, short-term funds, medium-term funds, long-term funds, and dynamic bond funds, among others. The choice of debt fund depends on the investor’s investment horizon, risk appetite, and investment goals.
Investors can buy and sell debt funds on an exchange, just like stocks, making them a convenient and accessible investment option. However, as with any investment, it is essential to understand the risks associated with debt funds and to consult a financial advisor before investing.
What You Need to Check in Bond
1.Coupon
The periodic interest payment made by the issuer. When bonds were first developed, the bond certificate had detachable coupons that the investor would send to the issuer to receive each interest payment. The term still applies to payments, even though coupons are no longer used to redeem them.
2.Face (Par) Value
The amount printed on the certificate. The face value represents the principal in the loan agreement, which is the amount the issuer pays at maturity of the bond.
3.Maturity date
The date the loan contract ends. At this time, the issuer pays the face value to the investor owns the bond.
4.Current Yield
This shows the true earning on the bonds. Formula is (Interest Earned/Market Price)*100. For example bond with coupon 10% & Market Price 130 and bond with coupon 8.5 % & Market Price 100 – Face Value 100. So the better yield is at 100rs bond price.
Understanding debt mutul funds
Things to look out in Mutual Funds Factsheet
- Portfolio Details: In case of debt schemes, factsheet also provide Credit Quality ( AAA, AA+, Sovereign etc.) Given by rating agencies, it also provide instrument wise breakup ( CPs, CDs, NCDs, Government Securities etc)
- Average Maturity: Average time involved in maturing all debt securities in the portfolio
- Modified Duration: A measure of price sensitivity of the debt portfolio to a change in interest rates.
- Yield To Maturity ( YTM): It broadly indicates the total returns investor will earn from interest payment and annualized gains or losses from bonds, if held until maturity.
Maturity Profile:
We have to check maturity profile of the portfolio details whose maturity is above >365 Days, Up to 91 days, > 91 days up to 365 days and Cash & Other Receivables. It should have according to the scheme maturity profile.
The inverse relationship is important,
As interest rates fall, bond prices rise;
As interest rates rise, bond prices fall.
Yield Curve
By using yield curve we can predict economic condition of the country. It has other benefit also but we will see meaning of the Yield curve.
1.Yield curve is graph plotted between yield and maturity, First one is normal yield curve which is the regular yield shows the short term needs are at less interest and longer needs are at higher interest rate to the debt taken by the government.
2.Second is flat yield curve which is current scenario in the India, as the both short term and long term are at same interest level this situation is good for liquid fund, or in short short term schemes.
3.Third one is the worst case scenario for the countries economy. As the short term rates are high so the government need to pay high interest and long term are less. This shows the country is in great danger for future terms.
Crisil Ratings
This ratings are representation of the bond/ Instrument credit worthiness and according to that ratings are provided.
This are varying between AAA to D, Investment grade is AAA to BBB for the mutual fund houses.
Credit Spread
The credit spread or quality spread is the difference between corporate bond and government supported bond, In other words this is an additional yield is received by the investor as the risk is more than the government supported.
Risk In Bond Investing
- Interest Rate Risk
- Credit Risk
- Reinvestment Risk
- Liquidity Risk
- Event Risk
Unique Characteristics of Debt Funds
- Liquidity
- Transparency
- Partial withdrawn
- Capital Appreciation
- NO TDS
Summary
Overall the debt funds and instruments are riskier due to default and the risk of capital loss. So according to me if you want to choose debt funds select government supported instruments and fund scheme which invest in those instruments. Though before investing consult your financial advisor and according to your risk profile.
Disclaimer: Mutual fund investments are subject to market risk, read all scheme related documents carefully.
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