Factors That Determine the Risk in a Debt Fund

Debt mutual funds are those which are said to have a low risk of market volatility as they invest in fixed income instruments like bonds, deposits and money market instruments. Thus, debt mutual funds are preferred by investors who do not like market risks and want stable returns on their investments. That being said, it is a mistake to believe that debt mutual funds do not carry any risk at all. The returns offered by debt mutual funds are not guaranteed because these funds are also exposed to certain risks. So, when you invest in debt fund online, you expose your investments to such risks. Do you know which risks are associated with debt mutual funds?

Debt mutual funds basically have two types of risks – credit risk and interest rate risk. Let’s have a look at these risks in details –

What is credit risk?

Credit risk is also called default risk. It is the risk of default of realisation of the invested deposit. Debt mutual funds invest in bonds and money market instruments which promise a guaranteed rate of return on investment. These instruments also have a maturity period after which the invested money is returned. If, however, the instruments fail to return the deposit or the interest thereon after maturity, it would be a default and the risk of non-payment of the deposit is called the credit risk or default risk.

Credit risk of a debt instrument is measured by credit rating agencies which rate the instruments based on their repayment capacity. The ratings can be AAA, AAA+, AAA-, B, D, etc. The higher the rating the lower would be the credit risk. Thus, fund managers try and pick debt instruments which have a high credit rating so that the credit risk of the portfolio is minimized. Moreover, if the instrument carries a high credit risk, it would also offer a higher return. So, if you are investing in a debt fund online which has a high return, you should check the credit rating of its underlying assets.

The credit rating of instruments is done periodically and if the rating of an underlying asset falls, the value of the asset also falls, which, negatively impacts the debt fund portfolio.

What is the interest rate risk?

Interest rates on debt instruments are not fixed. They are dynamic in nature which changes with the changing economic conditions. If the interest rates rise in the markets, the market price of the bond falls and vice-versa. Since debt mutual funds invest in bonds, a fall in the bond price reduces the fund’s value and the returns are reduced.  

So, when you are looking for the best debt fund, consider the interest rate risk of the fund vis-à-vis the modified duration. The concept of modified duration is used to measure the price sensitivity of the bond with a specified change in the interest rate. When the change in the rate of interest is multiplied by the modified duration, the expected change in the price of the debt fund can be ascertained. 

To invest in the best debt fund, choose funds whose portfolio has lower weighted average maturity duration. Such funds carry a lower interest rate risk than funds whose portfolios have a longer weighted average maturity duration.

Factors which determine the credit risk and interest rate risk in a debt fund include then following –

• Repo rate – if the repo rates fall, the value of the debt fund portfolio rises

• FII investment – if there is a heavy FII investment in debt instruments, the value of the debt fund portfolio would rise

• Domestic and international economy – economic factors directly impact the interest rates on debt instruments. They, therefore, directly impact the interest rate risk carried by debt mutual funds

Bear in mind these risks inherent in debt mutual funds when you invest in them. To invest in a debt fund online you can download the ETMONEY APP. It is a personal finance app which allows you to invest in the best debt fund. You can compare the performance of different debt fund online through this personal finance app and then choose one which offers the best returns at minimal risks. You can also invest online with minimal hassles at zero commissions and start your debt fund investments instantly. So, know the risks of debt funds and then invest in them through ETMONEY’s personal finance app for ease and convenience.

All you need to know about the best Balanced Mutual Funds

Best Balanced Mutual Funds

For a long time, investment experts have recommended balanced mutual funds to both first-time investors and even those who have a low risk appetite. This is because if you are a first-time investor, you might not be prepared to lose money during a volatile phase in the market. Even if you face it head-on, it might discourage you to never invest in the future! This is where balanced mutual funds come to your rescue.

So let’s find out what these balanced funds are and if it’s a good idea to invest in them:

What are balanced funds?

If you are a dilemma and do not know if equity or debt is better for you - then it is best to invest in a hybrid or balanced mutual fund. Of course, your age, risk appetite and the current market conditions play an important role. As an investor, if you are looking for diversification of your portfolio, then balanced mutual funds are your best bet. You can also re balance your portfolio on a regular basis.

When you decide to go for these funds, remember you can enjoy the benefits of both worlds, and at the same time, have a low-risk profile. What happens is that your money is invested in both equity and debt instruments (in a specific ratio) - this helps you to reap the rewards of diversification.

Are these equity or debt-oriented?

Now that’s a valid question. Your funds can either be equity or debt-oriented. If it’s equity-oriented, then a minimum of 65% of assets are in equities and the remaining in debt. If it’s the other way round, then 65% of assets are invested in debt, while the rest are in equities. A big advantage of these funds is that while all other kinds of mutual funds change asset allocation based on the highs and lows in the market; in the case of balanced funds, they behave in line with this ratio.

The`good part is if the market is in a bullish phase, you can reap high returns (thanks to equity); when the market is bullish, the debt component provides a safety net.

Things to remember when going for a balanced fund

If you’ve decided to go for a balanced fund, here are a few things you must keep in mind:

Risk appetite

It must be understood that these funds are not free from risk - yes, the debt component does offer some cushion, but there is an equity component that reacts to market fluctuations. The idea is to know that the risk is not as high as pure equity funds. To get the most out of balanced funds, make sure you keep re balancing the portfolio from time to time.

Moderate returns

As mentioned above, these funds are suitable for those investors who are not willing to take high risks. Historically, those balanced funds that are inclined towards equity have found to deliver moderate returns, generally to the tune of 10-12%. Some of you may ask, why moderate returns? This is because of the equity component that does fluctuate when the market goes through different cycles. Despite that, you know you’re going to get moderate returns - it gives a sense of security!

Expense ratio

When you go for balanced funds, there’s an annual fee that you must incur, called the expense ratio. By definition, it reflects the operating efficiency of the fund and forms an important criterion, especially when you have to select funds. When you decide to invest in balanced funds, make sure you check the expense ratio. If it has a low expense ratio, it is more advantageous - this is because you will have a higher take-home!

Advantages of Balanced Funds

Here are a few advantages of balanced funds:

Low risk: This is a huge advantage and one of the primary reasons why investors go for balanced funds. When the market is bullish, you can increase your exposure to equity, but when it is bullish, you can do the opposite. Balanced funds offer great flexibility and give the opportunity to re balance your portfolio from time to time!

Perfect for medium-term financial goals: If you have medium-term financial goals that can be fulfilled within five to seven years, then balanced funds are the perfect fit. Again, this works well for those who have a low risk appetite, but want a steady stream of income over a certain period.

Taxation benefits: Those funds that have 65% of their assets allocated in equities are taxed as equity funds. You can enjoy tax-free returns on these, in case you hold them for more than a year. In any other case, they are subject to short-term capital gains tax. Some investors also go for the dividend options, since dividends are tax free.

The verdict

Balanced funds are great for wealth creation without putting all the money in equity funds. The idea is to passively invest in equities and at the same time, averting risks in volatile market conditions. Of course, the returns achieved are moderate, but all in all, consistent returns are preferred over sharp losses. Keep re balancing funds to maximize return and reduce risk.