Investing in The Indian Debt Mutual Funds With Daniel Kahneman’s ‘Thinking Fast and Slow’ Approach

Debt mutual funds are a growing investment option for people looking for low-risk mutual fund schemes in India. It has its own set of followers that are increasing by the day and is often considered a good option for people entering into the scheme of investment.However, choosing to enter or exit a scheme requires decision making backed by logic and reasoning. This is where Daniel Kahneman, the famous author of bestseller 'Thinking Fast and Slow' and a Nobel prize winner, can help us.But what has a book by renowned economist and Nobel prize recipient Daniel got to do with the Indian debt market? Here’s how they relate:

Debt mutual funds are a low-risk investment option for people venturing into mutual fund schemes adhering to its investment into fixed income securities. Debt mutual funds invest in securities like corporate bonds, government securities, commercial papers, treasury bills, and more.These investment options come with a pre-decided maturity date and a fixed interest rate that is awarded to the buyer at the end of the term. As a result, it can be summed up as fixed income securities which out not affected by market fluctuations on an overall note, presenting them as a low-risk option.

Now let’s look at the two main decision types explained in the book ‘Thinking Fast and Slow’

• When the problem is simple.
• When the problem can be resolved easily and successfully.
• When the consequences of the answer are low and acceptable.

• When the problem is complex, and the solution requires logical reasoning.
• When you have not seen such a problem previously.
• When the stakes of being wrong are high and unacceptable.

• Thinking Fast – The System 1 Approach: This approach is also known as ‘Intuitive Thinking’, which borders on instantaneous, fast, and automatic instinct taking over during a decision-making process. These are often effortless and purely instinctive. This system is suited for:
• For example, a query like 2 +2 would come into this category.
• Thinking Slow – The System 2 Approach: Sample this question?Eggs and bread cost Rs 120 together. However, the eggs cost Rs 100 more than the bread. What is the cost of the bread? Intuitively you'd want to answer 20, right? However, the correct answer is actually 10.This is where the 'Thinking Slow' approach helps.This approach is known to be slow and logical, which requires consciousness and effort to conclude. These come in handy when you need to take logical reasoning to it. This is best suited for:

Let’s take this approach to debt mutual funds with an example.For say, an AMC closed 4 of its credit risk-oriented debt schemes.How would you react to such a situation based on the Thinking Fast and Slow approach?

• Thinking Fast – The System 1 Approach: For say, you may think, ‘Oh! No, I should move out from the debt schemes’ at first when you read the scenario. In this approach, you react instantaneously and may take a quick decision that may derail your progress.
• Thinking Slow – The System 2 Approach: If you go by with the System 2 approach of thinking slow, then you'll look to take logical decisions based on the scenario. For say, these four debt schemes were all based on credit strategy, and maybe that's a reason why they are closing down. The simple reasoning behind this is that there are different risk aspects involved with debt mutual funds .

These four schemes may have a portion of the funds lent to corporates with lower credit scores. This can significantly create a liquidity crunch as companies with lower credit scores do not have many liquid assets.That may be a reason why the AMC closed the four schemes, as they may have been under pressure to redeem the funds and transfer to high-quality or better debt funds. Hence the closure of these four credit risk-based debt schemes from the AMC.

• Credit Risk: This refers to the risk of defaulting from the issuer's side where they may not repay the principal and interest to the investor.
• Interest Rate Risk: This looks into the aspect of varying interest rates on the scheme and securities enlisted within the scheme.
• Liquidity Risk: This risk considers the inability of the fund house to provide adequate liquid funds for redemption.

Debt mutual funds that have their portfolio with lending to corporates with lower credit scores may tend to be in the liquidity risk and are not safe to venture into. However, more than 90% of Indian debt mutual funds have investments into good funds with high credit ratings. This ensures that debt remains one of the safe means for investment.Such scenarios of AMC closing down on the debt funds can arise at times. This can create an underlying effect on the investors who may get caught in two minds. The ‘Thinking Fast and Slow’ approach takes into consideration these situations and provides know-how on making the appropriate decisions. The System 1 Approach may lead you to make hastened decision and categorize all debt schemes as bad.While the System 2 Approach will provide you with logical reasoning and give you reasons why such a thing happened in the first place. This will help to make better decisions regarding debt mutual funds in the long run.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.