Last Updated : Jun 25, 2013 02:56 PM IST | Source:

How to analyse debt mutual funds?

Debt funds are largely overlooked by investors when it comes to investing in a fixed income space due to lack of knowledge. With better tax efficiency and various categories of schemes, this category makes an ideal choice for investors. Financial advisor Jitendra Solanki enlightens investors on how to analyze this segment of mutual funds.

Debt Mutual funds provides a good investment avenue for investors. With better tax efficiency and various categories of schemes availability, one can choose to invest based on investment horizon. Along with equity mutual funds, these funds are an ideal choice for creating an optimum mix required for a balanced portfolio. However, most investors face difficulty in analyzing a debt mutual fund scheme due to lack of knowledge and so avoid this alternative.

Here are some basics on how one can analyze various debt mutual funds scheme:

1. Liquid Funds: These funds invest in short term securities such as treasury bills, Commercial Papers, Certificate of Deposits and call money. The maturity of these securities runs up to 91 days.  A liquid fund with higher exposure in commercial papers is considered to be more volatile as these securities are generally illiquid.  So the fund may be producing exceptional return but will be on a higher risk. Similarly which NBFCs it is exposed more, what credit ratings the securities carry (although most short term securities are on higher ratings) and the corpus of the scheme matters in a liquid fund. Funds with less corpus may have high concentration to few issuers which is risky. All this information is useful in selecting a liquid fund.

2. Ultra Short Term Debt Funds: These funds are similar to liquid funds but can invest in securities of more than 91 days maturity. Since large chunk of the securities hold by these funds are traded, their prices impact NAV of Ultra Funds more than liquid fund. Thus these funds are more volatile. Contrary to liquid funds, this category of schemes caters to a 3 months investment horizon. So to analyze an ultra short term funds one need to look at the portfolio with same parameters as liquid funds.

3. Short Term Debt Funds: These funds invest in various securities such as corporate papers, government bonds and bank certificate of deposit. The maturity of securities in these funds generally ranges from 1-2 years and are mark to market.  Within this category one need to look at the portfolio composition of the fund. Funds which will be highly exposed to corporate papers will be more volatile although it may offer an opportunity of producing higher returns. Among these papers debentures forms a major portion of some of the short term debt funds and so the credit rating of corporate papers will be a factor to watch for. On other side funds with more exposure to certificate of deposit will be able to produce steady returns and less risky in comparison. Within short term funds there are categories like short term income fund, short term bond fund, Gilt short term or short term funds differentiated on the basis of securities they hold as discussed above.

4. Income Funds: The long term income funds generally invest in a combination of government securities, certificates of deposits, corporate bonds and money market instruments. The average maturity of these securities is longer and impacted by interest rate movement. However, with exposure of CDs and Corporate Bonds with different maturities, these funds are considered to be less volatile. While analyzing portfolio of an income funds the credit rating of securities will be a major factor to look in as longer term debt securities have to be rated and any fund with more exposure of low rating security will offer higher returns but will also be high on risk radar. There are funds with lower maturities also which vary in exposure to these securities.

5. Gilt Funds- A gilt fund investments majorly in government securities (G-Secs) along with zero-coupon bonds and treasury bills, certificates of deposit, commercial paper etc. Since G-Sec prices are more vulnerable to rise or fall in interest rate, long term gilt funds carry highest impact of interest rate movement.  Within this category, the exposure to G-Sec and other securities and the variation in the average maturity of the scheme will indicate the level of risk it carries and so is a factor to analyze the funds.

Analysis of any debt fund is difficult unless you are not well aware of the underline investments. Although above discussed parameters are good to be used to analyze the respective debt mutual fund scheme, there are other factors like past performance, fund manager, corpus size  and expense ratio of the fund which should also be considered to sort out your preferred list.

- Jitendra P.S.Solanki
The author is CFP and Founder of JS Financial Advisors

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First Published on Jun 25, 2013 01:44 pm
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