What mutual fund investors can learn from the recent debt fund crisis?

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One good thing about mutual fund investments is that there are end number schemes to choose from. If your goal is to save taxes and earn capital appreciation in the long run then there is ELSS for that. Also, there are multiple AMCs and fund houses offering ELSS funds. This means that investors can compare multiple ELSS schemes, check which one is a better performing among the lot and make an informed investment decision. Similarly, if you are a risk averse investor or someone who is planning to switch from conservative schemes and looking forward to investing in mutual funds, such individuals generally consider investing in debt funds. Debt funds are considered to be less risky as compared to equity related mutual funds. That’s because debt funds invest in fixed income securities like certificates of deposits, call money, debentures, company fixed deposits, government bonds etc. which are known to generate regular income.

However, in the past few months debt funds, which are generally supposed to provide a safety cushion to an investor’s mutual fund portfolio have been underperforming. This has left investors aghast as they are unable to understand where to park their money. Debt funds generally don the role of balance the risk of a portfolio that is a mix of equity and debt assets. Here’s why debt funds have been underperforming from the past and what we as investors can learn from it:

High yield may not always equal to high returns

It is a common understanding among investors that debt funds that have a high yield ratio will always provide higher capital gains. However, this has turned out to be exactly the opposite for debt funds in the recent past. That’s because if you take a closer look at a debt fund portfolio, the high yield factor is a result of the fund investing in papers and bonds that are of high risk. Although low rated papers give the fund an opportunity to fetch higher returns, it also carries a higher amount of risk which can affect an investor’s debt fund portfolio.

Concentrated risk

Apart from exposing its portfolio to low rated papers, a debt fund can also prove to be a risky investment if it exposes its assets to any one particular company. High concentration towards any one specific bond or company may increase the risk profile of a debt fund.

A short term scheme investing in securities that mature over the long term

If a debt fund invests in a security whose maturity period is not synchronizing with the average maturity period of the fund, then this can prove to be problematic. If the average maturity of the underlying assets of a debt fund is way longer than that of the duration of the fund, this may affect the scheme’s performance and it may not be able to offer capital appreciation.

This is the reason why several mutual fund advisors ask investors to do a thorough background check of the mutual fund, be it equity, debt or any other type before investing. Apart from checking the fund’s expense ratio, its past performance it is also necessary for investors to assess the assets in which it funds the fund investors. It is always good if one determines their risk appetite before investing in debt funds so that they do not end up investing beyond their boundaries. To give their investments a systematic approach, investors can opt for a Systematic Investment Plan. SIP is an easy and convenient way to invest in debt funds. One can invest small fixed amounts at regular intervals and achieve their financial goals through SIP investment. Investors can also use an online SIP calculator to understand how much money they need to invest at regular intervals in order to get closer to their financial goals.

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