The Safer Bet

Debt mutual funds offer more tax benefits and returns than other fixed income instruments.

- Renu Yadav

Debt investments are a part of most portfolios. These work as a shock absorber for investors by delivering stable, though not very high, returns. Among the debt instruments available, debt mutual funds are one of the most recommended, especially when interest rates are falling -- they have delivered double-digit returns in the past two years and are tax efficient (see Tax Gains).

However, a few recent incidents have got investors worried. Those who had invested in four debt funds of Taurus Mutual Fund were in for a shock when net asset values, or NAVs, of their funds fell 7-11 per cent in a single day in February this year. Such losses are difficult to digest even for equity fund investors. The reason for the fall was the downgrade of rating of debt papers of Ballarpur Industries in which the funds had invested. This is not the sole instance of debt funds delivering negative returns. In August 2015, two schemes of JPMorgan Mutual Fund had suffered losses due to downgrade of debt papers of Amtek Auto.

BE INFORMED

These incidents highlight the inherent risks in debt funds that mutual fund investors should be aware about. Among debt securities, there are different instruments that a fund can take exposure to. These include government securities, certificate of deposit, commercial paper and nonconvertible debentures. The funds’ performance will depend on how the underlying instruments are doing.

“The extent of fall or rise in prices of fixed income securities is a function of the coupon rate, days to maturity and the increase or decrease in level of interest rates,” says Avnish Jain, Head, Fixed Income, Canara Robeco Mutual Fund. There are two types of risks that these funds carry.

Credit risk: