Are debt funds safe? which debt funds to invest in 2020?

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Are debt funds safe?

Are debt funds safe? – With the recent episode of Franklin Templeton AMC winding up 6 of its debt funds, every retail investor has

a question in their mind – are debt funds safe to invest?

Normally debt funds are marketed by the MF distributors as a very safe investment product. They are meant to protect the customers from the equity MF type of risk where in equity MF the investors can loose a lot of money.

But with the recent events its looking like the debt funds are more riskier than equity funds as there is a hope of recovery in equity MF but when a company defaults on its payments to a debt mutual fund then debt mutual fund NAV takes a hit and never recovers!

It all started in September 2018 when IL&FS defaulted on its payments to Small Industries Development Bank of India.  Slowly the debt funds started writing down their investments in DHFL, Vodafone idea, Yes bank etc.

With Yes bank default a lot of debt mutual funds took large hit to their NAVs, some of their funds have taken hit up to 25% on their NAVs. No retail investor in their wildest dreams would have imagined that their debt mutual fund investment can go down by 25%!

So why did this happen with debt funds?

Some fund houses have invested in commercial papers of companies which initially were rated excellent by rating agencies but they later turned out to be junk investments and these funds had to write down their investments in those companies. Eventually leading to investors loosing their money.

The fund houses were investing in those companies in a hope of higher returns and beating their counter parts in other AMCs. This worked well till 2018 as companies didn’t default till then. Franklin Templeton AMC was among the best debt fund AMC till 2018.  

With defaults they started giving negative returns!

After Vodafone Idea defaults, Franklin Templeton AMCs 6 funds have given massive decline on their NAVs on a single day. These are the 6 funds which were winded up on 23rd April 2020. May be the warning signs were already there for the investors to exit!

Do read – Franklin Templeton debt funds- What went wrong?

Franklin debt funds

Are debt funds safe – If yes, Which ones?

There are so many types of debt funds available in the market. They serve different purposes and they invest in different instruments.

It’s very difficult for a normal retail investor to know which debt fund is safe for them out of so many options.

Let’s do an analysis of all the debt funds available in the market and see their performance over the years. We will do the analysis of the funds which are in market for at least 5 years.

Liquid funds

Liquid funds invest in bonds having maturity of up to 3 months. They are suitable to park the amount that you have set aside to meet any emergency needs or any surplus money that you don’t need for the next few months to an year. You can expect to earn better returns than what you would get from a bank account.

The risk of incurring a loss in these funds is negligible but they do not guarantee returns or safety of capital. Though rare, there have been few instances when liquid funds have incurred losses.

Performances of liquid MFs over last 5 years:-

Should retail investor invest in liquid funds? – Yes. Stick to the large liquid funds.

Liquid funds

Overnight funds

Overnight funds invest in bonds having maturity of just one day (hence the name ‘Overnight’). They are suitable for institutional investors looking to park their surplus money for a few days or weeks to earn a bit extra on the sum which would otherwise lie idle in a bank account. The risk of incurring a loss in these funds is negligible but they do not guarantee returns or safety of capital.

Performances of Overnight MFs over last 5 years:-

Should retail investor invest in overnight funds? – Yes. If you don’t want to trust liquid funds and don’t want to risk your money at all. Liquid funds are better than overnight funds in terms of returns.

Overnight funds

Low duration funds

Low Duration debt funds invest in bonds maturing in 6 months to 1 year time. They aim to earn slightly better returns than what you can get from a bank account or a short duration fixed deposit. The risk of incurring a loss in these funds is negligible but they do not guarantee returns or safety of capital.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of low duration MFs over last 5 years:-

Should retail investor invest in low duration funds?

Yes- only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Low duration funds

Medium duration funds

Medium Duration debt funds invest in bonds maturing in 3 to 4 years’ time. They aim to earn slightly better returns than inflation and bank fixed deposits of a similar duration. The risk of incurring a loss in these funds over the said time frame is low, but they do not guarantee returns or safety of capital.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of medium duration MFs over last 5 years:-

Should retail investor invest in medium duration funds?

Yes- only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Medium duration funds

Short duration funds

Short Duration debt funds are suitable to invest your money for a duration of 1 year to 3 years. You can expect to earn higher returns than what a bank fixed deposit of a similar duration can fetch.

The risk of incurring a loss in these funds over the said time frame is low, but they do not guarantee returns or safety of capital like a bank deposit. There have been instances when short duration funds have incurred losses.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of short duration MFs over last 5 years:-

Should retail investor invest in short duration funds?

Yes- only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Short duration funds

Ultra short duration funds

Ultra Short Duration debt funds invest in bonds maturing in 3 to 6 months’ time. They aim to earn slightly better returns than what you can get from a bank account or a short duration fixed deposit. The risk of incurring a loss in these funds is negligible but they do not guarantee returns or safety of capital.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of Ultra short duration MFs over last 5 years:-

Should retail investor invest in Ultra Short duration funds?

Yes- only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Ultra short duration fund

Money Market funds

Money Market debt funds invest in bonds with maturity of up to 1 year. They aim to earn slightly better returns than what you can get from a bank account or a short duration fixed deposit. The risk of incurring a loss in these funds is negligible but they do not guarantee returns or safety of capital.

Performances of Money market MFs over last 5 years:-

Should retail investor invest in Money market funds –

Yes- although no fund have given negative returns in these category. The returns of this category is almost same as liquid funds. So retail investors are better off sticking to liquid funds.

Money market fund

Gilt Funds

This is a fund that invests mainly in bonds issued by the government of India. These bonds do not carry any risk of default since the repayment of investors’ money is backed by the government. But they are prone to sharper ups and downs because of changes in interest rates.

Performances of Gilt MFs over last 5 years:-

Should retail investor invest in Gilt funds

Yes- in existing scenario where interest rate is heading downwards and bond yields are going down. Remember these funds can give negative returns when the bond yields start rising up!

If you see there is spike in returns for this year as the bond yields have crashed this year!

Gilt funds

Dynamic Bond fund

Dynamic Bond funds have the freedom to invest in bonds of any duration. Depending upon where it expects to earn maximum returns, the fund management team decides whether to invest in bonds maturing in a few months time or in the ones maturing several years later.

 Therefore, they are the most versatile type of debt funds available.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of Dynamic bond MFs over last 5 years:-

Should retail investor invest in Dynamic bond funds?

Yes- only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Dynamic bond fund

Corporate bond fund

Corporate Bond funds have a narrow mandate of investing mainly in the highest rated corporate bonds.

Since these funds invest in different category of companies there is a high chance of defaults if the AMC has invested in a company which doesn’t pay the money back. If you see the below chart; there are funds which has given negative returns in these category.

Performances of Corporate bond MFs over last 5 years:-

Should retail investor invest in Corporate bond funds?

Yes –  only if you can examine the investments of your fund

No – If you don’t understand how the fund invests your money

Corporate bond fund

Banking and PSU funds

This is a fund that invests mainly in bonds issued by banks, public sector undertakings (PSUs) and public financial institutions.

Banking and PSU funds have done well in last 5 years. There is no fund which has pefromed negatively. 

Performances of Banking and PSU MFs over last 5 years:-

Should retail investor invest in Banking and PSU funds?

Yes-Since these funds invests in high quality papers of banks and PSUs they are relatively safe. Remember that these funds do well when interest rates go down but they perform badly when interest rates go up.

Bankind and PSU funds

Credit risk funds

Credit risk funds invest mainly in corporate bonds which are below the highest rating assigned by credit rating agencies. The lower rating indicates a higher possibility of these bonds defaulting on repayment of investors’ money. Therefore, these funds are the riskiest of all types of debt funds. 

However, they compensate for this additional risk with a higher return potential as these bonds offer better rates of interest than highest rated bonds. Moreover, investors can also benefit if the rating of these bonds is subsequently upgraded.

Performances of Credit risk MFs over last 5 years:-

Should retail investor invest in Credit risk funds?

No – This category is the most hit by the ongoing debt fund issues. Retail investors should avoid this fund category completely.

Credit risk funds

Are debt funds safe? – Conclusion

Earlier people used to ask are mutual funds safe? then they started asking are equity mutual funds safe? Now they are asking are debt mutual funds safe?

Are debt funds safe? – Yes they are safe if you understand the debt fund!

With the recent events its clearly evident that the image of debt funds have taken a big dent. But at the same time investors should understand that not all debt funds are bad. If you invest in good quality debt funds then you will be safe. Just make sure you understand the debt funds before you invest in it. 

The Govt of India have started a debt fund ETF for its public sector companies called Bharat Bind ETF. It has 2 options Bharat Bond ETF 2023 and Bharat bind ETF 2030. These funds have papers of all public limited companies of rating AAA. This is an excellent option of the retail investors to look at.

You can alternatively look at Fund of funds for Bharat bond ETF which is available as mutual fund to invest.

Do read – How to select mutual funds India?

Disclaimer –  Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 

Data for above analysis are obtained from www.moneycontrol.com and www.valueresearchonline.com


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One thought on “Are debt funds safe? which debt funds to invest in 2020?

  • May 4, 2020 at 6:00 am
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    Very useful article on all kinds of debt funds and their performance. But the labels are not clearly visible in the Bar graphs. IT would be great if you could pls. change them into a darker shade and bigger font.
    Thanks

    Reply

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