3 must-know concepts about debt fundsWith interest rates on the downturn, there are no dearth of suggestions on which debt...
debt funds with longer investment horizons, such as income funds (eg: Canara Robeco Income:8.05 years) and gilt funds (eg:...
Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual ...
Upcoming SlideShare
Loading in …5
×

3 must know concepts about debt funds

438 views
192 views

Published on

With interest rates on the downturn, there are no dearth of suggestions on which debt fund to invest in. Before you act on them, it would do you good to understand these concepts regarding interest rates and its impact on a fund's portfolio.

Published in: Economy & Finance, Business
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
438
On SlideShare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
3
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

3 must know concepts about debt funds

  1. 1. 3 must-know concepts about debt fundsWith interest rates on the downturn, there are no dearth of suggestions on which debt fund toinvest in. Before you act on them, it would do you good to understand these concepts regardinginterest rates and its impact on a funds portfolio.Author : iFast Content TeamThe recent policy easing by the central bank and the lower-than-expected inflation numbershave triggered a host of investment recommendations in the relevant debt funds.With regards to the changing interest rate scenario, there are three terms that investors mustunderstand. Yield to Maturity (YTM)YTM of a debt fund portfolio is the rate of return an investor could expect if all thesecurities/bonds in the portfolio are held until maturity. For instance, if an income fund has aYTM of 10%, it means that if the portfolio remains the same until all the holdings mature, thenthe return to the investor would be 10%.However, the YTM does not remain constant as the portfolios are actively managed by the fundmanager.Yield is different from the coupon rate. Let’s say a bond has a face value of Rs 100 with an 8%coupon rate. This means that the investor will earn Rs 8 per annum for every Rs 100 invested.Now let’s say interest rates in the economy rise to 10%.However, the Rs 8 per annum is fixed. So to increase the yield to 10%, the price of the bond willhave to drop to Rs 80. Similarly, the reverse will take place when interest rates fall. If interestrates fall to 6%, the price of the bond will go up to Rs 133.This is how the yield fluctuates to changes in the interest rate of the economy. And, this is howthe price of the bond moves inversely to interest rates.Why it is important:YTM broadly indicates to the investor the kind of returns that could be expected. But it is not adefinite indicator since returns may vary due mark-to-market valuations or changes in theportfolio. Weighted Average Maturity (WAM)This is more commonly referred to as the average maturity of a debt fund. It is the average timeit takes for securities in the portfolio to mature, weighted in proportion to the amount invested.Eg:Rs 1,000 invested in Bond A matures in 5 yearsRs 2,000 invested in Bond B matures in 10 yearsTotal investment in debt portfolio = Rs 3,000WAM = (1000/3000)*5 + (1000/3000)*10 = 8.33 yearsWhy it is important:Average maturity indicates the sensitivity of the fund portfolio to interest rate changes. Thehigher the average maturity the greater is the volatility of returns in the fund. This is seen in
  2. 2. debt funds with longer investment horizons, such as income funds (eg: Canara Robeco Income:8.05 years) and gilt funds (eg: ICICI Prudential Gilt Fund Investment Plan: 10.81 years). On theother hand, average maturities in liquid funds have been restricted to 90 days while ultra short-term funds could go higher but are usually less than a year, making them less volatile to interestrate movements.The average maturity of a scheme gives you a broad guideline in terms of finding a debt fundsuitable for the time horizon of your investment. Modified Duration (MD)As mentioned above, bond prices and interest rates are inversely related. This means, if there isa rise in interest rates then there is a fall in the price of the bond. If there is a fall in interestrates, then the price of bond will rise. MD is the change in the value a bond or debt security inresponse to the change in interest rates. So let’s say the MD of the bond is 4.23. This means thatthe price of the bond will increase to 4.23 with a 1% (100 basis point) increase in interest rates.Basically, MD provides a good indication of a bond’s sensitivity to a change in interest rates. Thehigher the duration, the more volatility the bond exhibits with a 1% change in interest rates.The MD of a portfolio will take into account all the instruments. So naturally it would changeevery time there is a change in the composition of the portfolio.Why it is important:By and large, it is a more accurate measure of sensitivity of the portfolio than average maturity.Low duration funds like liquid and ultra short-term are less volatile. However, longer durationfunds like income and gilt are likely to perform better in a falling interest rate scenario becauseof the capital appreciation in the portfolio. For instance, the growth plans of the followingschemes from the same fund house all have different MDs: Birla Sun Life Ultra Short Term Fund(0.72), Birla Sun Life Short Term (1.22), and Birla Sun Life Income Plus (5.67).How to use this informationAll these above terms can be seen in the factsheets published by the asset managementcompanies on each of their individual funds. On a more advisory note, while investments andredemptions in liquid and ultra short-term funds can be done anytime, it would requireexpertise and insight to get the timing right in investments in longer duration funds, which aresubject to volatility and negative returns in the interim. Take advice from your financial plannerif you are unsure of your move and would like to capitalize on interest rate movements.Also read: How to make an ultra short-term fund work for youBy investing via Fundsupermart, you have access to 41 AMCs in India. Heres why youshould invest via Fundsupermart.com.At no cost to you, the Fundsupermart Mobile Application helps you take charge of yourportfolio with up-to-date information at your fingertipsTo buy and sell mutual funds online, click here.
  3. 3. Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual fundsof any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or bematerially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or saleof any mutual fund. No investment decision should be taken without first viewing a mutual funds scheme information documentincluding statement of additional information. Any advice herein is made on a general basis and does not take into account thespecific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, andlegal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative ofthe future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise.Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website. Please read ourdisclaimer in the website. Risk Factors: Mutual funds, like securities investments, are subject to market risks and there is noguarantee against loss in the Scheme or that the Scheme’s objectives will be achieved. As with any investment in securities, the NAVof the Units issued under the Scheme can go up or down depending on various factors and forces affecting capital markets. Pastperformance of the Sponsor/the AMC/the Mutual Fund does not indicate the future performance of the Scheme. The name of theScheme does not in any manner indicate the quality of the Scheme, its future prospects or returns. Please read the Statement ofAdditional Information and Scheme Information Document carefully before investing.

×