Debt mutual funds are attractive products, allowing investors to invest in a spectrum of debt tenure and papers, originators and credit quality. Debt mutual fund schemes are diversified within subcategories, including short-term, banking, and PSU debt, as well as corporate debt, on the basis of credit quality, duration, and originators. Mutual fund schemes provide professional portfolio management, good diversification, carrying forward losses for around eight years and amazing liquidity. But the question is, how can you analyse which debt mutual funds are a better investment? Let’s acknowledge the answer to this question.
Understanding Debt Mutual Fund
A debt fund is an MF scheme that includes investing in fixed-income instruments, such as corporate debt securities, corporate and government bonds, as well as money market instruments that provide appreciation in capital. Debt funds are also considered bond funds or income funds.
Analyse Debt Mutual Fund: Key Factors
Some of the key factors that help you analyse that mutual fund are as follows:
Duration
Duration measures the sensitivity of the bond prices to fluctuations in the rate of interest. It is calculated in terms of years. The greater the duration, the more sensitive the underlying papers will be. Liquid funds come with the shortest, modified duration and are least sensitive to the rate of interest.
For example, the average modified duration of:
- Liquid funds – 0.15 years
- Short-term debt funds – 2.18 years
- Long-term debt funds – 4.68 years
Investors with a short-term investment horizon and low-risk tolerance must prefer liquid or short-term debt funds. Conservative investors must not invest in long-term debt funds.
Average Maturity
In an individual bond, maturity is the time after the initial investment is repaid to the bondholder by the bond issuer. Mutual funds invest in several bonds with multiple maturities. Hence, to calculate the average maturity of a debt fund, you must use the weighted average method to consider the time required for all the bonds to mature in the fund’s portfolio.
Yield to Maturity
The earnings you make from yourmutual fund investment over a certain period, including the entire interim cash flow, is the yield. The interest earned on debt instruments or the dividends from stocks is determined for yield calculation. It is expressed as the percentage of the instrument’s face value or the present market value. Yield to maturity is the total debt fund returns which you might expect from your investments in bonds, provided the bond is held till its maturity and the proceeds of that bond are invested in the same. As stocks do not come with a maturity date, this concern is applicable only to bonds.
Yield to maturity= Total interest on from the bond over the years/ face value of the bond
Bondholders avail interest from the bonds. Hence, if you want to evaluate and make a wise investment choice about the bond to be purchased, calculate the present value of these future coupons.
Credit Rating
Credit rating stands as a quantitative assessment of a certain debt instrument that a company issues. Each bond transaction comes with two counterparties to a deal- the lender and the borrower. With an associated credit rating, the lender determines the following:
- Risk of default to the instrument – the greater the rating, the lesser the risk
- Rate of interest- The greater the borrower’s credit rating, the lesser the risk of default. So, the lender applies a lesser rate of interest to the borrower.
When discussing long-term ratings, all the credit rating agencies follow a similar skill. Refer to the table below to acknowledge the rating symbols and their description.
| Instrument Rating | Rating Symbols |
| Highest Safety | AAA |
| High Safety | AA |
| Adequate Safety | A |
| Moderate Safety | BBB |
| Moderate Risk | BB |
| High Risk | B |
| Very High Risk | C |
| Default | D |
Benchmark
The performance of debt funds is measured against a benchmark index. It helps an investor monitor the performance of the fund since inception against its benchmark. It offers an insight into the performance of the funds in the past. Once the investor is clear with the application of these concepts for creating a strong debt investment strategy, it becomes easy for them to make a wise decision of selecting the right fund as per their monetary goals and risk appetite. It is always advisable to understand and read all the details about a particular fund before investing.
Conclusion
In comparison to equity mutual funds, debt funds are less volatile but are not completely risk-free. Debt funds face market, credit risk, market, risk, and interest rate risk. Their NAVs are connected to the market and might experience high fluctuations. However, several debt funds come with zero default risk, such as gilt funds or liquid funds, which are 100% safe from credit risk.
