The correction in
Equity market and interest rate yields going up shifted the focus of investors
to debt instruments. Government also raised the interest rates for small
savings instruments by 0.40% from Oct’2018 to December’2018 quarter. The debt
funds of mutual funds are also in lime light. Debt funds obviously scores over
traditional instruments if you hold for more than 3 years because of indexation
benefit. Yields in mutual funds particularly in credit funds and corporate bond
funds are higher compared to traditional investments. The returns of 3 years
FMPs are also attractive if you don’t want daily volatility. But is debt risk
free? The answer is no.
There is no doubt that
debt also plays an important role in the portfolio and you can’t avoid it. But
it is also important to note that if you aim for higher returns, higher risk is
inbuilt in it. Therefore it is important to know the risk, charges and tax
implications before investing in debt funds. You may have to suffer loss if you
jump into the debt funds only looking at YTM (Yield till Maturity) which most
of the investors do. Knowing Modified duration, tax implications and charges
levied are also important aspect before investing in debt funds. Very few know
that in hand return is not YTM but YTM minus fund management charges. If you
are in a credit funds or corporate bond funds then interest rate movement can
also impact funds day to day performance.
SEBI recently lowered
the TER both in debt and equity funds and which will bring down overall charges.
It is surely going to benefit the investors but it is important to note that
final date of implementation is still awaited. More importantly lower charges
will not take away the risk of default and risk of interest rate volatility
which is likely to continue for some more time. Surprisingly, even charges are
regularised there is still difference in charges levied in the schemes within
the same category. The difference is too high that if you ignore your return
can go down drastically. I think SEBI is also not ware about the disproportion
charges levied in the same category. Just to clarify that lower charges does
not mean higher returns but the fund management also plays important role.
The US Federal reserve
hiked the interest rate by 0.25% third time in this year. The RBI may also hike the interest
rate or change the stance which most of the experts believe in its review meeting to be
held on 5th October’2018. Yields may go up again if RBI raises repo rate.
Surely It’s not the time to chase the returns.
Let us evaluate the
three major categories of debts which attracts majority of the debt money. Liquid
funds are not considered as risk and charges are low compared to other
categories. It is true that categorisation will help investors in identifying
the nature of risk inbuilt in the product but there are other things also to be
looked into. I am sure that this will help you deciding the debt funds very
well. The source of information is from Aditya Birla Capital
1)
Credit Funds:
As per SEBI definition
given under categorisation these funds have to invest minimum 65% of the corpus
below highest rated corporate bonds. Means papers like AA or below rated papers
which are too risky. The recent ILFS downgrade has put a question mark on the
process of the mutual fund houses while investing people’s money in debt
markets. Now its known fact that fund houses depend largely on the rating
agencies for ratings and do not have in house mechanism to support it. In
credit funds the yields are very high but also the risk is. One mistake and
your corpus will be at risk, forget the interest part. We have seen negative
returns in liquid funds as well in recent past which tells us that debt funds
are also not risk free.
Another important thing
I would like to highlight is the charges. There are around 20 schemes in the
credit risk category and the average YTM is 9.76% and the average charges is 1.71%.
This means your net in hand return will be around 8.05% only post expenses.
Most of the investors invest in these funds looking at YTM only and ignore the
charges levied or mostly not aware about the same. Even more surprising is the
lowest charge in the category is 1.14% and highest is 1.89%. The difference is more
than 50%. How this can be allowed and is SEBI ignorant about this?
2)
Corporate Bond Funds:
As per SEBI definition
given under categorisation these funds have to invest minimum 80% of the corpus
in highest rated corporate bonds. These funds are much safer than the credit
risk funds but the YTM is also lower. There are around 20 schemes in this
category and the average YTM in these funds is 8.59% and the average charges is
0.86%. This means your net in hand return will be around 7.73% only post
expenses. Again the lowest charge in the category is 0.44% and highest is 1.55%.
The difference is more than 150% which nobody is talking about.
3)
Ultra Short Term Fund:
As per SEBI definition
given under categorisation these funds have to invest in instruments with
duration of 3 to 6 months. Surprisingly there is no mention about credit
quality of the papers. That means fund houses can take higher risk at the cost
of investors money. Please note that fund giving higher return in the category
is taking higher risk by putting money in below rated papers which can
backfire. These funds are relatively safer compared to above two funds as the
maturity is lower but again low paper can hit your investment badly.
There are around 20
schemes in this category and the average YTM is 7.84% and the average charges
is 0.73%. This means your net in hand return will be around 7.11% only post
expenses. Again the lowest charge in the category is 0.20% and highest is 1.15%.
The difference is 600% which nobody has noticed till date.
Investing in debt funds
is more critical compared to investing in equity. From above comparison it is
clear that you should invest in ultra short funds and be happy with 7.11%
return instead taking higher risk for just 0.50 to 0.75% higher. Evfen 3 years
FMP with quality paper is good option. Therefore “Advisor Jaruri Hai”. Direct
plans can save on expenses but what about the credit risk and tax planning? I
know the higher charges are passed to distributors but this must stop. I hope
SEBI will look into charges within the same category and give relief to
investors. There is no denial that charges are within the limits prescribed but
high difference with in the category is not justified.
This article first published at indianotes.com
https://www.indianotes.com/en/articles/dont-jump-in-to-debt-funds-without-knowing-risk-and-charges/
