Why must you invest in debt funds? Meet MC30’s debt fund stars

About the data: Interest rates on education loans for all listed (BSE) public and private banks have been considered for data compilation; Banks for which data is not available on their websites have not been considered. Data collected from respective banks' website as on September 3, 2020. Banks are listed in ascending order on the basis of interest rate i.e. bank offering the lowest interest rate on education loan (loan amount of up to Rs 20 lakh) is placed at top and highest at the bottom. Lowest rates offered by the banks on loan up to Rs 20 lakh has been considered in the table. EMI is calculated on the basis of Interest rate mentioned in the table for Rs 20-lakh loan with tenure of seven years (processing and other charges assumed to be zero for EMI calculation); *excluding GST

Your mutual fund portfolio should not just consist of equity funds. That is why MC30; Moneycontrol’s all-new curated portfolios of 30 mutual fund schemes consist of eight debt funds. But there are 16 debt fund categories out there. Why does MC30 have only three?

Only investments; not parking of cash

MC30 is an investment portfolio. Here, we only recommend schemes that are meant for your investments. We have chosen to stick to just three categories; short-term, corporate bond and, Banking & PSU Debt funds. Some debt funds, however, are also meant for you park your surplus cash. These are extremely short-term categories, such as liquid funds, overnight funds, low duration funds, money market funds and so on. MC30 has left all of them out.

Then, there are categories that are volatile (long-term debt funds and government securities funds) or carry credit risk (credit risk funds and some medium-term funds). Long-term bond funds and government securities can be volatile; a sudden interest rate reversal can wipe out an entire year’s gains. Since debt funds are meant to bring stability to your portfolio (as opposed to the volatile equity funds), we felt it’s best to stick to the conservative side and recommend less volatile funds.

Also see: The complete MC30 basket of mutual fund schemes

Why debt funds?

But the big question: why have debt funds in your portfolio?

At a younger age, equity allocation is typically higher. But as we grow older, debt instruments play a bigger role. If equity funds are the way to go to build a portfolio for the long term and beating inflation, debt funds keep your risk levels in check.

Also read: Presenting MC30’s largest equity fund schemes

For instance, when the equity markets failed to deliver positive or optimal returns in the years such as 2011, 2015 and 2018, debt funds came to rescue, delivered positive returns and managed to offset the damage caused due to the underperformance equity counterpart.

 Also read: How to use MC30?

MC30 penalises credit risks

The Franklin Templeton episode taught us many lessons on how too much credit risks can create havoc to our portfolios. MC30 penalised debt funds that invest in securities rated AA and lower. The higher this proportion, the higher was the penalty we gave them. This brought down the scheme’s risk-adjusted ranking.

Too much investment in a single group? Not good

The capital market regulator, Securities and Exchange Board of India (SEBI) does not allow funds to invest more than 20 percent of their corpuses in a single group. At MC30, we kept the threshold at 10 percent. Any exposure to a single group beyond this, as per the latest portfolio, gets penalised.

Also read: MC30: The methodology behind the curated basket of mutual fund schemes

Today, let’s take a closer look at our short-term debt funds.

ICICI Prudential Short Term Fund

ICICI Prudential Short Term Fund (ISTF) is managed actively to ensure reasonable returns, without compromising on portfolio quality. Apart from investing in g-secs (government securities) opportunistically, it invests up to 20 percent of its assets in AA rated and equivalent securities.

Fund manager Manish Banthia says that although the scheme invests in AA rated assets, the fund house’s in-house risk management team monitors the holdings closely. ISTF has held around 7 percent exposure to perpetual bonds (as on June 2021).

At Rs 22,069 crore (as on July 30, 2021), ISTF is the second-largest scheme in its category at present. Its portfolio is well-diversified with over 200 debt securities; the most it has invested in a single corporate group is 4.6 percent.

 HDFC Short Term Debt Fund

HDFC Short Term Debt Fund (HSTF) maintains the portfolio duration between one and three years. It invests over 80 percent of its corpus in the highest rated instruments; around 6-10 percent gets allocated to AA rated and equivalent papers. Despite being hit by the IL&FS crisis in 2019, the scheme recovered. Its holding in IL&FS was just 0.5 percent. And although it holds around 4.8 percent in AT-1 bonds, we don’t think that’s any problem for the scheme.

Axis Short Term Fund

Axis Short Term Fund (ASTF) has been a consistent performer that doesn’t take credit risk. Aside from investing in highly-rated bonds, it allocates to g-secs too, to earn some extra returns.

Also see: The complete MC30 basket of mutual fund schemes

Other than miniscule exposure to Dewan Housing Finance Corporation, the portfolio has consistently been clean. And ASTF recovered its dues from the company.

Like many other debt funds, it has some investments (around 2 percent) in AT1 bonds, but fund manager Devang Shah says there is no risk as they are issued by good-quality banks.