Debt Mutual Funds: A re-look at the fundamental elements
A Mutual Fund is a type of financial vehicle made up of a pool of money collected from large number of investors to invest in securities such as stocks, bonds, money market instruments, and other assets. Each Mutual Fund scheme is managed by professional Fund Manager(s). Debt Mutual Funds are a category of Mutual Funds that invest in different types of debt instruments with varying time frames in terms of maturity. These debt instruments have given interest rates and time-frames, but the returns are not assured as they substantially depend on the fluctuations in interest rates.
If government or any organization wants to raise funds, they may borrow from the market by issuing debt instruments. In return, the government or the organization promises to pay a regular interest to the lender apart from returning the principal amount on maturity. By buying a debt instruments, you’re lending money to government or the organization.
Credit Ratings
Credit Risk is the risk that a lender will not get paid principal and interests on time as scheduled on a loan or other borrower obligations. Debt securities are assigned a ‘credit rating’. It helps to assess the ability of the issuer of the securities / bonds to pay back their debt, over a certain period of time. These ratings are published by independent rating organizations such as CARE, CRISIL, ICRA, etc. Credit ratings are one amongst various criteria used by Asset Management Companies to evaluate the credit worthiness of issuers of fixed income securities.
Returns
Debt Mutual Funds generate returns in the following two ways:
- Interest income: The fixed income securities/bonds have a predetermined interest rate termed as the coupon rate. An interest amount is earned at periodic intervals.
- Change in valuation: Debt Mutual Fund schemes generate returns due to change in value of their individual holdings. The value of their holdings change due to global and/or domestic interest rate and credit rating movements.
Types of Debt Mutual Funds
There are 16 types of Debt Mutual Funds. Types are to suit different time horizons and portfolio preferences of investors.
Suitability of Debt Mutual Funds
Debt Mutual Funds may be a suitable investment option for conservative investors who do not want to undertake much risk. Risk in Debt Mutual Funds is usually lesser than that of in Equity Mutual Funds or Hybrid Mutual Funds. Hence, returns are historically much lesser than that of Equity Mutual Funds or Hybrid Mutual Funds in the long run.
Considering subjective financial goals, time horizons of investments, risk profile, personal aspects as well as macroeconomic scenarios, one must not randomly invest his/her hard earned money in Mutual Funds without proper knowledge of the products. Product suitability framework must be obeyed to avoid needless financial distress.
Mutual Funds investments are subject to market risks, read all scheme related documents carefully. The NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. The past performance does not necessarily indicate future performance of the schemes. Mutual Funds do not guarantee any return(s). Investors are requested to review the prospectus carefully and obtain expert professional advice with regard to specific legal, tax and financial implications of the investment/participation in the scheme.
SEBI Circular
Circular, dated October 6, 2017, bearing no. SEBI/HO/IMD/DF3/CIR/P/2017/114, issued by Securities and Exchange Board of India, regarding “Categorization and Rationalization of Mutual Fund Schemes” should be exclusively considered for details.
Disclaimer
Mind Map prepared, information and opinions expressed are completely personal. I shall not be held liable for any improper or incorrect use of the information described and/or contained herein and I assume no responsibility for anyone’s use of the information/opinion.
