5debt fund-april 2013

8/12/2019 5debt Fund-April 2013

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Debt funds are not as "safe" as they sound.

20th Apr 2013 ARCHIVES|EQUITYMASTER HOMEPAGE

A client who wishes to minimise risk says: "I want to be really safe please make sure your

!ersonal# financial planner puts all my money in a debt fund."

And that ri$ht there is a dan$erous misconception.

Debt funds are not "really safe". %hey ha&e a lot of inherent risksin them which you should be

aware of before you decide to in&est in them ' e&en if they ha&e been recommended by your

financial ad&isor.

And for the "e(tra risk" that you ha&e taken in debt funds compared to li)uid funds *or bank

Ds+ you should be compensated with a hi$her return.

Safety is not assured.

A debt fund in&ests in securities which typically mature more than ,0 days. -ost debt funds

may ha&e in&estments where the a&era$e maturity is anywhere from 3 years to years. A li)uid

fund by contrast in&ests in securities that mature in less than ,0 days.

%he lon$er one is in&ested in somethin$ the hi$her the chance that somethin$ can $o wron$:

the risk increases.

or e(ample if you lent money to your nei$hbour for one day the "risk" of him not payin$ is

limited to that one day. /ou will make your decision on whether to lend *or not to lend+ lookin$ at

&arious factors that could $o wron$ *or ri$ht+ in that one day period. "Is your nei$hbour likely to

disappear o&erni$ht" may be your first )uestion

ut what if the nei$hbour asks you for a loan for 10 years because he wishes to build a factory

to manufacture cars #ow your entire assessment of the loan should ha&e chan$ed. In addition

to worryin$ about whether your nei$hbour will disappear for 342 ni$hts *10 years ( 34 days

plus some lap year days+ you need to start askin$ him a whole bunch of )uestions *why cars

what is the demand competition ser&ice centres where will he $et the money from when will

he start production where will he $et his raw materials from etc. etc.+. And you will also worry

about the rate of interest you should char$e him. If you char$e him say 105 you will feel

foolish if the rates of interest sur$e to 205 ne(t month. If you had not locked in your money at105 you could ha&e been a lender at 205. 6owe&er if the rates of interest decline to 45 you

will feel $ood that you locked in your loan at 105.

7eepin$ this basic principle in mind: the lon$er you are locked in the hi$her your "risk" here is

a $raph of two funds from 6D8 -utual und: one is a li)uid fund and the other is a fi(ed

income fund.

Grap !" H#$C $i%ed In&o'e $und does (etter tan te H#$C )i*uid $und+ fro' O&to(er

,--- ti.. Mar& /!+ ,-!/0
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%he 6D8 9i)uid und has a portfolio with an a&era$e maturity of 43 days as per the fact sheet

of -arch 31 2013.

%he 6D8 i(ed Income und has a portfolio with an a&era$e maturity of ,.4 years as per thefact sheet of -arch 31 2013.

#ote how the 6D8 i(ed Income und ' with a relati&ely hi$her risk than the 6D8 9i)uid

und because it is locked in securities that mature after , years ' has performed better from

;ctober 2000 when both the unds were in e(istence.

ut note the


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In&estin$ in 6D8 9i)uid und is like lendin$ money to your nei$hbour for 43 days *that is the

a&era$e maturity of the securities it owns+ $ettin$ it back from him and decidin$ to lend it to

him a$ain for 43 days a$ain ' sort of rollin$ o&er the loan within a short period of time if you felt

like it. And if you feel uncomfortable ' because somethin$ may ha&e chan$ed in your

assessment of his ability to pay or e&en in the interest rate you wish to char$e him ' you can

decide not to roll o&er the loan. %he smooth line represents the "43'day" worry.

;f course like in any in&estment when you in&est also determines whether you made money '

or $ot compensated ' for the hi$her risk.

As you can see an in&estment in the 6D8 9i)uid und would ha&e $i&en you better sleep

*fewer anuary 1 200.

Grap ," H#$C )i*uid $und does (etter tan H#$C $i%ed In&o'e $und+ sin&e 1anuary !+

,--20

?eco$nise that a li)uid fund and a debt fund both own securities which $i&e a fi(ed rate of

return. ut the funds are different. And you need to be aware of that and see whether it matches

your potential needs.


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Ta(.e !" 3y te $unds are different

)i*uid $und #e(t $unds

@hat does the und typicallyown

;bli$ations of a borrower to repay acertain amount called the principal ata fi(ed time

;bli$ations of a borrower to repay a certainamount called the principal at a fi(ed time

Interest earned on in&estments %ypically 5 to 5 %ypically 5 to 105

%enure: when will the money bereturned to the und

6as to be returned within ,0 days ?an$es between 3 years and years

8an these holdin$s be sold byund to someone else is therea secondary market

/es these are traded acti&ely butmost unds will hold these till they"mature" and the borrower repays theloan

/es these are traded acti&ely and mostunds will sell them in the secondary market

@hat happens if interest ratessur$e sharply

8an rein&est )uickly in instrumentsthat $i&e hi$h interest rates

=tuck ' will take a lon$er and lar$er hit on theportfolio &alue the #AB

@hat if interest rates fallsharply

@ill be forced to rein&est the portfolioat lower interest rates then the futurereturns will decline ' but no lon$ termloss on the portfolio &alue the #AB

@ill see a lar$e sur$e in the &alue of itsportfolio of e(istin$ securities sur$e in #AB

=hould this be in your portfolio

/es as an alternati&e to i(edDeposits particularly if you need themoney in a shorter unknown period oftime

;nly a small proportion of your "fi(edincome" portfolio should be in thisC this

actually is for more sophisticated in&estorswho wish to "make a call" on the direction ofinterest rates

%ypical commissions paid bymutual fund houses todistributors and financialad&isors who "sell" thisproduct

0.045 to 0.105 0.305 to 1.05

=ource: !ersonal#

In&estors lookin$ to in&est in instruments which ha&e a fi(ed rate of return and want to ensure

that their capital &alue is secure should consider:

1. %he &arious ta('incenti&e sa&in$ schemes like !ostal =a&in$s

2. %he i(ed Deposits at different banks

3. %he 9i)uid unds.

%he rates of return in these abo&e instruments may not compensate you for the increase in

prices for inflation. ut your capital is safe.

or those wishin$ to earnhi$her returns to beat inflationand take some risk on their capital

there is the option of in&estin$ in the &arious debt funds. %hey may be called -! monthly

Income products or debt funds ' but reco$nise that their underlyin$ portfolios are sub


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Income und has performed better than the 6D8 9i)uid und since ;ctober 2000. %he points

to note are:

1. the risk *the

5debt fund-april 2013

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