5 Key Parameters for Debt Fund Investment

Looking for a safe avenue that generates good returns with limited exposure to market volatility? Consider exploring the option of debt mutual funds . The category is perfect for investors with low-risk tolerance as it invests mostly in corporate bonds, government securities, treasury bills, commercial paper, and other money market instruments with slim chances of default.However, it’s prudent to evaluate certain parameters before choosing this investment strategy.

The expense ratio is the annual fee charged by Asset Management Companies (AMCs) for managing a particular scheme. This is applicable to both direct and regular plans. A high expense ratio translates into low net returns for the investor. Operating costs matter in debt funds because their returns are subdued and more predictable compared to equities. Hence it is important to keep an eye on the expense ratio at the very onset to reap maximum benefit. Many times, it is the expense ratio that can be a differentiating factor in debt funds within the same category.

Yield to maturity (YTM) is the anticipated return from the debt scheme if held till maturity. It takes into account all the payments made as per schedule along with the reinvestment to generate additional income. The YTM provides a snapshot of the annualised return on the fund and helps determine whether the investment is worthwhile. It must be noted that this parameter is only indicative, and the fund may not generate the projected return.

Modified duration basically indicates the sensitivity of a fund to changes in interest rate. The relationship between the interest rate and the price of the debt fund is inversely proportionate. If the interest rate goes down the Net Asset Value (NAV) of securities appreciates and vice versa. Thus, debt schemes with a higher duration perform better when interest rates fall while those with shorter tenure outperform when the interest rates go up.

The interest rates in the market can impact returns on debt instruments.The value of previously issued bonds (the simplest form of debt instruments) surges when interest rates fall and plummet when they go up. As a result, the financial worth of the portfolio decreases, and investors get lured towards the newly offered bonds that promise better returns. It helps to factor in the prevailing interest rate trends when deciding on an investment.

The credit rating of the debt funds must be assessed when investing in this category. It essentially reflects the issuer’s creditworthiness, financial health, and repayment capacity. Agencies use different methodologies to rate schemes based on their ability to make timely payments. Debt instruments assigned an AAA and AA+ rating are regarded as safe and secure while those with a ‘C’ rating are deemed risky with higher odds of defaulting.

Debt fund investment is considered a safe option that is generally not impacted by fluctuations in the financial market. Nonetheless, there is a need to exercise caution before taking the plunge. Investors must focus on the risks involved and select debt instruments only after thorough research based on the above parameters to ensure they are a good buy.

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.