Things To Know Before Investing In Debt Mutual Funds

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Things To Know Before Investing In Debt Mutual Funds
Ashfaque Ismail - 17 July 2019

Debt mutual funds have been at the receiving end of ongoing crisis that has shaken a large part of industry concerning mutual funds, NBFCs and other housing finance corporations. The segment has been hit hard by the collapse of Infrastructure Leasing and Finance Corporation (IL&FS) in September 2018. Before this collapse, IL&FS had been operating through a complex web of over 200 subsidiaries running these firms as special purpose vehicles (SPVs), and extending ‘indiscriminate’ infrastructure loans to entities that failed to repay the principal. Since September 2018, many companies like Essel Group and Dewan Housing and Finance Corporation (DHFL) have failed to release payment to their Non-Convertible Debenture (NCDs) holders on time. As a result Kotak AMC and HDFC Mutual Fund delayed their fixed maturity plans. Debt mutual funds have long been considered an alternative to the other fixed income assets or bank fixed deposits but they come with market risk. There is also credit risk attached to debt mutual funds. So should you invest in debt mutual funds? Here is a myth buster you should always take into account every time you start investment in debt mutual funds.

For wealth creation

Financial Planners say first time investors even the old-timers approach them with a certain set of doubts in their mind. Many of the investors believe debt mutual funds are a tool to create wealth in the long term, which is not the case. Investors put their hard earned money in debt mutual funds in the hope that they will get ‘hefty’ returns. Many of them also are unaware of the fact that debt mutual funds are similar to bank fixed deposits or for that matter any other fixed income instrument. Debt mutual funds are exposed to market risk, the only thing that distinguishes them from fixed income assets like bank fixed deposits. In some cases, debt mutual funds attract more tax than the bank FDs.

No market risk

Since debt mutual funds are based on the concept of ‘debt’ they are considered by many investors as free from any market risk. There is a significant number of investors that believes only equity related mutual funds come with market risk. That is not true. Debt mutual funds also come with their share of market risk. They are connected with bonds or bond prices, which has inverse effect on the rate of return from these debt mutual funds. In simple terms, if the bond prices fall the rate of return from these debt mutual funds will go up.

No risk in credit risk

Many of the investors with the desire of earning higher return go for credit risk funds, a category of debt mutual funds, as they are either unaware of the risk or think that there is no harm in investing in these funds. Credit risk funds which are lower rated pay back better returns comparing other mutual funds. However, financial planners say this category of funds is meant for those individuals whoi have deep pocket and who could bear the shock of ‘instant money loss’ without having an impact on their wealth.

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