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Debt funds: Then and now
AxisDirect-O-Nomics
Aug 01, 2018 | Source: Value Research
SEBI's fund classification system has resulted in the creation of 16 debt fund categories. We tell you what are they and how should you pick from them
If you found debt funds a bewildering asset class to start with, SEBI's reclassification exercise has not made your life much simpler as it has now allowed 16 types of debt funds. But navigating this classification becomes easier once you recognise that SEBI has tried to distinguish funds on three key parameters - portfolio duration, the kind of debt securities held and credit risk taken.
On duration, SEBI has divided debt funds into nine buckets in place of the existing four. There's now a debt category for every maturity profile - from parking overnight money to investing in seven-year plus securities. The existing dynamic-bond fund category has also been retained.
Debt funds will now use the Macaulay duration, in place of average maturity, to measure their portfolio duration. That's not as complicated as it sounds. Macaulay duration is simply the weighted average number of years over which the bonds in the fund's portfolio will receive regular interest payments. The longer the duration, the more is the fund's vulnerability to interest-rate swings. Ideally, debt-fund investors must match their own holding period to the Macaulay duration of the fund they're buying to reduce the interest-rate risk.
But if you go by the kinds of bonds held, there are three SEBI-approved debt-fund types - corporate bond funds, gilt funds and banking/PSU funds. Based on the extent of credit risk taken (investments in bonds with lower credit ratings), again, there's a special category of credit-risk funds.
While the menu of debt funds on offer may seem befuddling, here are two easy routes for layman investors to deal with the new debt categories.
One of the useful outcomes of the SEBI rejig is that it has drawn a bright line between corporate bond funds that take on credit risks and those that invest only in high-quality paper. Earlier, that line was quite blurred as 'accrual funds', 'income funds' and 'opportunities' funds could sit on quite a lot of lower-rated bonds unknown to the investor.
Therefore, if you are looking for a bank FD or corporate FD substitute among debt funds, corporate bond funds and banking and PSU funds offer good alternatives, where you make limited compromises on credit quality. While corporate bond funds are required to invest 80 per cent in highly rated corporate bonds, banking and PSU funds have to park 80 per cent of their assets in the stated sectors. Credit-risk funds, with a minimum 65 per cent exposure to bonds below the highest rating, can carry default risks. Use them mainly as a replacement for your direct investments, if any, in lower-rated corporate FDs or high-yield NCDs.
As before, a three-year holding period is essential to reap the maximum tax efficiencies from debt mutual funds. And systematic withdrawal plans are better vehicles to set up a regular 'income' from debt funds than the heavily taxed dividend options.
In short, you can build a hands-free debt portfolio just from three categories of debt funds - liquid funds (for emergency money), low-duration funds (for safe money without a maturity date) and corporate bond/PSU funds (for better returns than bank FD, along with tax efficiency).
Here's a list of all the debt fund categories.
Related Keyword
Mutual Funds
Debt / Income Funds
Long term capital gain/loss
Liquid Fund
AxisDirect-O-Nomics
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