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Monday, July 8, 2013

How to generate higher returns from debt mutual funds ?

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Call 0 94 8300 8300 (India)

 

INVESTORS are gradually discovering that mutual funds offer better options of wealth creation over traditional investment opportunities. Take the case of the recent rally in gilt funds and income funds owing to decline in interest rates.


The former returned over 15 per cent over a year till May 31, while the latter returned almost 14 per cent (category returns). These funds (referred as duration funds) benefit when interest rates decline owing to the inverse relationship between yield (interest rates) and price (
NAV). Further, funds with a longer maturity benefit more than those with a shorter maturity.


Traditional fixed income instruments on the other hand reduce their coupon when interest rates decline. This has seen many investors opting for debt mutual funds, against bank fixed deposits.

The following are the major benefits of debt mutual funds: Variety: They invest in a mix of fixed income securities covering different durations such as treasury bills, government securities, corporate bonds, money market instruments to name a few. Investors, thus, get the variety of investing across the debt spectrum through the mutual fund route.


Convenience:

They are professionally managed by expert fund managers and are available with a low ticket size across investment frequencies.


Liquidity:

All open-ended mutual funds allow withdrawal of money without any lock-in (subject to an exit load). While close ended mutual funds like fixed maturity plans have a specific maturity period, these are listed on stock exchanges to provide liquidity.


Diversification: Debt funds help to diversify an investor's portfolio across asset classes as they are relatively less volatile than equity and gold.


Tax efficiency:

 

Debt mutual funds are tax efficient compared with bank fixed deposits (See table above).


Indexation benefit: Indexation is an option available for investors to manage their inflation-adjusted returns. The Income-tax Act allows investors to use inflation as a tool to reduce their tax liability from income generated through debt mutual funds and bonds. The indexation benefit applies if such investments are held for more than 12 months. The same does not apply to bank fixed deposits and other small savings where the interest earned is taxed as per applicable marginal tax slabs of 10 per cent, 20 per cent and 30 per cent.


Duration vs credit opportunities:

Debt mutual funds provide investors an opportunity to benefit from the underlying interest rate scenario. For instance, when interest rates rise, short maturity funds offer better returns as they benefit from the rise in underlying rates; but when interest rates fall, long-term maturity funds and gilt funds benefit as the price of the underlying long term securities rise in this phase. Investors, thus, need to closely monitor the interest rate scenario to benefit from the movements in interest rates.

Besides duration funds, another category of funds investors can look at is credit opportunity funds -which try to gain from the higher yields offered by securities that are a notch lower in credit rating vis-àvis the highest-rated securities. One could thus benefit from higher returns from these funds by taking a marginally higher credit risk.

Debt mutual funds thus provide investors the choice of benefiting both from duration play and credit play.

As long as investors are associated with a qualified independent financial adviser (IFA) and distributors, they will have access to good advice that will enable them to invest correctly. Today, advisers are well educated and have scientific methods towards investment. Our advice is that the investor should talk to their financial adviser, understand his/her risk profile and requirements and accordingly take appropriate risks that suit their profile.

Happy Investing!!

We can help. Call 0 94 8300 8300 (India)

Leave your comment with mail ID and we will answer them

OR

You can write back to us at PrajnaCapital [at] Gmail [dot] Com

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