What all to look for while investing in debt funds…..
All debt funds have fixed income or money market instruments like government securities, bonds, treasury bills, certificates of deposit, commercial papers etc. in the portfolio. All these assets carry risks of various nature. For example, government securities and treasury bills are considered to risk free while a junk bond from a company will carry high risk. As an investor you should be aware of the assets that are there or expected to be there in the portfolio of the debt fund that you intend to invest.
Please remember: Gilts and T-bills carry almost no risk. Outside of these papers, lower the credit rating, higher is the risk.
Like equity funds, there is no one solution for your investment goals when you look at debt funds. So there are various types of debt funds to match your investment horizon. For example, liquid funds are for extremely short term investment horizon, of up to three months. On the other hand, long term bond funds are for conservative investors who are happy with a high single-digit or low double digit returns on their portfolio over several years.
There are debt funds which could be open ended which provide easy liquidity as the fund house only buys and sells its units on a regular basis. There are also the ones which are closed ended, meaning in these funds you invest once and remain invested till the duration of the fund. If you need money in the interim, you hardly get a chance to redeem. So be clear about when and how you would need the money that you are investing.
There are lots of debt funds which come with an exit load for a specific period of time, usually some months from the date of first investment. This means if you want to redeem within these specified number of months after investing in the fund for the first time, you need to forgo a part of your total corpus, say up to 1%, in that fund during that period of time. This is a type of regulator-advised ‘penalty’ by a fund house to discourage those investors who look for quick and easy money.
FUND MANAGER RISKS
You should remember that fund managers may at times may not be able to read the market direction rightly, leading to under performance of the fund you are invested in.
Year ago when mutual funds launched gilt funds, there was a mad rush for those funds. Investors though one could never lose money in gilt funds. The reality of the market is that the government promises to pay you back the full amount that is due on gilts. But the price of the gilt, when traded in the market, fluctuates, and at times wildly, leading to gains or losses in the fund’s portfolio. This is true for almost all types of funds.