When one says mutual funds, the top of the mind recall is that of equity and equity mutual funds. The next perception is about volatility of the net asset values of these funds. Debt and fixed income mutual funds usually do not figure in the portfolios of many retail investors. Sometimes, investors interpret them as ‘dead funds’. Fixed income funds or debt funds are those where the income is considered to be fixed (as in fixed deposits).
Debt funds perform two basic functionalities for investors — cash management or temporary parking (short-term debt funds) and stable balancing investment (long-term debt funds). Debt MFs are not as glamorous as equity mutual funds, but they perform an important job for investors’ wealth creation in the following areas:
Most debt funds invest in instruments that give a fixed interest for certain tenure.
Principal Protection: Though this aspect can’t be over-emphasised due to regulations, most of the short-term debt funds at all times have given principal protection.
Tax-Free Returns: They give tax-free returns in the hand of the investors and ensure lower tax outgo when compared to other fixed income instruments like FDs.
Low Risk: Most of the debt funds invest only in top notch credit-rated instruments. These ratings are carried out by neutral credit rating agencies. A comparison of fixed-income products to debt MFs shows that the latter offers superior features on return, liquidity and tax advantages as a composite package.
Bank FDs: Though returns can be high, depending on the interest rate cycle, there are no tax advantage. There’s a stringent lock in penalty. Safety is high.
Company FDs: The returns are comparable to bank FDs. Company FDs also have similar characteristics with regard to taxability and lock-in/penalty features. Safety is medium-to-low with the risk being higher than bank FDs.
Post Office Savings: They are similar to bank FDs. They offer higher return but with low liquidity. Risk is low with the highest safety.
PPF: It offers high returns but is low on liquidity. There are tax benefits but lock-in is long.
Debt Funds: Returns are moderate-to-high, depending on the rate cycles. Liquidity is very high with mostly no penalties. Tax advantages vis-a-vis fixed deposits are quite high. On an average, equity mutual fund returns have been quite volatile over the past five years and have underperformed the indices. Debt funds have given low returns in comparison but have given consistent returns along with principal protection.
The rule of thumb in the market is that when equity markets do well, debt markets right” alt=”bank fixed deposit” height=”198″ src=”http://www.investmentkit.com/articles/wp-content/uploads/200_Fixed-Deposit-2.jpg” width=”200″ />stay lukewarm and vice versa. If one can see the returns of various funds over the past five years, then the variance between debt and equity funds is quite low in comparison to the one-year and two-year periods. Debt fund managers juggle the duration of instruments in times of bearish markets such as those prevalent right now. Fund managers take advantage of interest rate cycles and increase the duration or maturity when interest rates and do the opposite when interest rates rise.
Given the features and other characteristics of debt funds, it will be advisable for investors not to ignore these products. Just to reiterate, compared to all the other assets available to investors, debt funds offer advantages in terms of returns, liquidity, safety and tax advantages.
Source: Economic Times
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January 30, 2011