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Debt Funds Can Be Dangerous

Author: Venkata Ravi Ram/Wednesday, May 30, 2018/Categories: Mutual Funds, Expert View

Debt Funds Can Be Dangerous

There are loads of ads for different mutual funds, each ends with a neat caveat: “Mutual fund investments are subject to market risks, read scheme related documents carefully before investing”.

When we normally hear the term “market” in relation with investments, most common market that comes to mind is the share market. When it comes to debt funds, the general impression created is that they are just another type of fixed deposits. Nothing can be further from truth. Before we look at what makes debt funds dangerous at times, a quick peek at bond markets. Bonds (your old-fashioned FD in the neighborhood bank is also a ‘bond’) are fixed income securities that pay the holder a specified interest rate for a specified period of time. Since both time and rate are defined, these are called fixed-income investments as against the variable income be it dividends or, capital appreciation of equity shares.

A fundamental law that governs all markets is the law of demand-supply. This is demonstrated in the vegetable market where prices fluctuate on a daily basis. This law is applicable to most markets including bond markets. The bond prices decrease when interest rates increase and vice-versa. Reason is simple, the interest income to the buyer of the bond on that day gets equalised.

We are generally told, debt is boring, gives lower returns and is safer. But, if a debt fund manager makes a wrong call on interest rates as to what the RBI would do with interest rates, before the monetary policy is announced, that debt fund’s NAV gets singed badly, like it happened few times in the recent past. Of course, slick story-telling follows on different platforms justifying the wrong call but, mainly to justify the fat fees. Apart from interest rate risk, the bigger risk is the credit rating risk. This decides if you get would your money back, at all. Yeah, you read that right. There have been cases where investors lost heavily on principal itself like JPMorgan’s debt funds’ investment losing value when Amtek Auto Ltd bonds were downgraded from AA- rating to a C, similarly Taurus MF debt fund investors lost 12% in a single day when BILT was downgraded from IND BBB- to IND D.

So, it is not all hunky-dory in the debt-fund land. Checking the asset quality of the debt fund is an important step before investing. Take some time out to really read the scheme document, if it allows the fund manager to invest in lower rated (higher risk!) debt. Check the maturity of the bonds in the fund, if it is generally matching with your needs. All these information is available in fact sheets. Debt funds do have market related risks. An investment in the wrong debt fund could go down the drain!

The author writes commentaries on contemporary financial, business, taxation and political issues.

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