Misconceptions about debt funds

 

Even though debt funds are the biggest contributors to the mutual fund corpus in India, there is surprisingly not much literature on debt funds.

Let me start by clearing some misconceptions about debt funds:

1. Debt mutual funds  are EXACTLY like bonds:

Debt funds and bonds are very different. If you can lock in today into a PSU bond at 9% current yield for a 20 year period, it is an amazing saving instrument. I daresay no fund scheme can give such a good return over such a long period. If they had zero coupon and fully back ended interest, I would have been happier, but this is a brilliant product.

2. Debt fund is only for the retired person

Not true at all. Even when you are younger, say 45 a debt fund makes sense. Invest in a longer duration fund and remove only when you retire.

3. Debt funds carry NO RISK, especially gilt funds

Debt funds carry 2 types of risk (like any debt product) – one is the risk of default (on a part of the portfolio, not the full portfolio) and interest rate risk. When interest rates go up, the value of your bond fund will go down and the reverse is also true. So depending on YOUR time horizon you should choose your funds. This means you can LOSE money EVEN in government guaranteed ‘gilt’ fund. However you can NEVER EVER lose money in a NOMINAL sense in a gilt bought and held to maturity.

4. All debt funds are the same!

Sorry, no. If you have money for the short term – say 3 days or you are accumulating money for your retirement about 30 years away you will have to choose DIFFERENT PRODUCTS. For a short duration you need to choose funds with low duration (like liquid fund) whereas for a long term requirement you will choose an Income fund or a gilt fund. Your choice will depend on a) your own outlook about the time you wish to hold the fund scheme b) how much fluctuation you can stomach c) at what point of the interest rate curve we are sitting at.

5. Indians invest very heavily in debt funds

Partially true and partially false. Indians invest in bank debts and sometimes even in post offices and LIC policies. However most of the money you see in the mutual funds are the corporate monies. These are parked in liquid funds, Fixed Maturity Plans, etc…

6. Debt funds are cheap

Not true at all. You need to be careful about debt fund costs.

7. Debt funds are useless, one should stick to bank fixed deposits, especially for older people

Wrong. Debt funds are the ONLY way you could consider deferring the tax on debt investments. If you had a bank fixed deposit you would pay tax on interest earned on a regular basis. You could convert this to a capital gain by investing in growth option.

8. It is easy to build a debt fund portfolio

Wow!! It is far more difficult to build a dynamic bond portfolio – and the Indian market does not have enough bonds on tap – so building a debt portfolio is also ALMOST a nightmare!!

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4 Responses to “Misconceptions about debt funds”

  1. Thank you Subra Sir!!
    Can you please suggest some short term and long term debt funds with low cost?

  2. Dear Sir, any views on my earlier comment on long term similar returns for liquid funds and other riskier funds?

  3. I must admit to having been burnt by buying at the wrong time. I will stick with balanced, lesson learnt.

  4. Hi Subra,

    When we look at the returns of the mutual fund in (say valueresearchonline.com) there is considerable difference (Approx 1% CGAR) between direct and non-direct options.
    Axis Equity direct 1 year return is 11.86%, where as Axis equity is 10.88%. As far as I understand trailing commission is the only difference since between direct and non-direct options after entry load has been taken away. Can you please advise/ educate on this as well.

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