10. Debt Funds

• Debt Funds contrary to expectation have associated risk

• Risk is not in the Asset, Risk is in the Price - Warren

Debt Funds Vs Bank FD

• Tax efficient - Funds

  • 3+ yrs is treated as LTCG with indexation

Debt Funds

• Example: RBI 8% 10yr Bond, Invest 1000

  • t=1yr, Return 80

  • t=2yr, Return 80

  • t=10yr, Return 80+1000

• Risks

  • Credit risk - Bond Company default

  • Interest rate sensitive risk - Inflation\Interest rate increase to 10%, still you will get bond rate say 8%

    • If you wanna sell bond after 2.5 yrs, say bank interest rate increased to 10%

    • Now buyer would only pay Rs 800 for Rs 1000 bond, to get 10% return 80 of 800

    • This means a loss from 1000 to 800, driven by interest rate sensitivity

    • If bank interest rate reduced to 5%, value of bond may increase to 1600 giving 5% return 80 of 1600

    • This means bond value may increase or decrease during the tenure

• Invest in Bonds

  • Short term

    • Govt Treasuries by RBI

    • Corporate Commercial papers

    • Average maturity is very small ~50days

    • Interest rate sensitivity is very low

  • Long term

    • Govt

    • Corporate

    • Maturity is high

    • Default risk for Corporate (Not visibility)

Type of Funds

• Liquid

• Ultra short

• Long term

How to Choose the Fund

• Category of fund say Debt Liquid

• Direct Fund

• Expense Ratio - Low is good

• Benchmark - should be same as fund, e.g. Liquid

• Riskometer - Low for less interest rate fluctuation

• Risk Grade - Negligible for Liquid fund

• Expense Ratio - 0 is preferred

• Average maturity - say 0.11 means ~40days for Liquid fund, this tells interest rate fluctuation wont be applicable

• YTM - Yield to maturity - means return if bonds were hold till maturity without selling

• Constituents