Do you require debt MFs at all?

Previously the IL & FS fiasco and now Franklin debacle, has made many retail debt MF investors anxious about their investments in debt MFs. Even recently, HSBC short duration fund and HSBC low duration fund have written down its exposure to troubled Dewan Housing Finance Ltd (DHFL) papers. This resulted in nine per cent to ten per cent of erosion in its net asset value (NAV). Even Principal Asset Management Company (AMC) have witnessed fall in NAV close to five per cent to seven per cent. This fall was recorded by its four debt MFs holding DHFL papers. Having said that, all these things happening around debt MFs have led us to a question as to whether at all investors (retail) requires debt MF? In this article, we have explained as to when you should avoid investing in debt MF.

Securing capital

If your top-most priority is to secure your capital then, you should avoid investment in debt MFs. Debt MFs being market-linked are not just prone to interest rate risks but also accounts of any capital gains and losses made on bonds investments. Some funds such as those having investments in long duration papers are prone to capital losses. Even the liquid funds, those considered the safest among debt MFs, witnessed negative returns in March. Hence, if your main objective is to secure your invested capital, then avoid debt MFs and invest in banks or post office deposits.

Regular income

Many people, specifically those who are retired, rely heavily on instruments that provide them regular income. Here again if your highest priority is regular predictable income, then investing in debt MFs would be a bad idea. When we consider fixed deposits (FDs), we are aware of the income that we are going to receive for the tenure. Even in case of pension plans, we are aware of what we are going to get in hand on regular basis. But as debt MFs are volatile in nature compared to other safer investment avenues like FDs, one cannot predict the income that you might receive from the same. Hence, if your highest priority is regular income and you cannot bear even a single rupee drop in your regular income, then it is better to stay away from debt MFs.

Wealth preservation

It is rightly said that, not just creation but also preservation of wealth is equally important. If in that sense, that is what you wish to do, then it is better to stay away from debt MFs. They are more prone to interest rate risk and credit risk. Though, short-term papers are relatively less prone to interest rate sensitivity, they do pose credit risk. Many a times while selecting funds, we do stress more on credit ratings. However, we need to understand that, these ratings can change overnight. Such a scenario happened with DHFL, where even their AA rated paper changed to D (default) rating. So, if you wish to preserve your wealth, which also means what you earn on it does not matter, then it makes more sense to avoid debt MFs. Rather you can consider investing in government deposits offered by banks and post offices.

Now few might argue that, should debt MFs be fully ignored by the retail investors’ community? No, that’s not the case. Those who have wealth creation goal can invest in debt MFs from a risk management perspective. Also, you need to understand the kind of risk you wish to undertake and your investment horizon before opting for debt MFs. One should understand that, debt MFs are not just meant to earn higher returns on your investment. In fact, if you can take so much risk to earn higher returns in debt MFs, then it would be wiser to invest in equity MFs. Hence, use debt MFs only as a risk management tool and not as a tool to create wealth.