Factors to consider when assessing the risk of fixed-income mutual funds; take a look!

When investing in a fixed-income mutual fund, an investor must consider the risks involved in it. Here are the two most important factors to consider!

Investing in a mutual fund necessitates some fundamental understanding as well as market awareness. An investor may invest through an intermediary (fund house) or perform extensive research to invest on his own; that is where the importance of 'mutual fund evaluation' comes into play! 

Investors always consider the reputation of the fund house and fund manager, assets under management, portfolio turnover ratio, expense ratio, and exit load when evaluating the performance of a mutual fund. However, when investing in a fixed-income mutual fund, an investor must consider the risks involved in it. 

Here are the two most important factors to consider when assessing the risk of fixed-income mutual funds - 

Yield to maturity - Yield to maturity (YTM) is the total returns expected based on the assumption that the bond is held to maturity and the recurring cash flows i.e. coupons are ploughed back into the bond. A fund’s YTM can be an indicator of risk when compared to the overall fund category’s YTM. For example, if the YTM of the overall fund category and a particular fund from the category stands at 5 per cent & 7 per cent, respectively, it implies that the fund is taking on additional risk-chasing higher yield. Ideally, a fund’s YTM should match or be slightly lower than the category’s YTM. 

Modified duration - Modified duration is a measure of how much the price of a fund changes because of the change in its yield to maturity (YTM). For example, if the modified duration of a fund is three years and the market interest rate slips by 1 per cent, then the fund’s price will surge by 3 per cent. On the contrary, if the interest rate rises by a per cent, the fund’s price will drop by 3 per cent. If an investor wants to minimise interest rate risk, then Debt Funds with lower modified duration would be the ideal choice. If interest rates are expected to decline in the future, then investors must opt for funds with higher modified duration.