How to create your debt MF portfolio?
Some of the recent events have affected many debt mutual funds and it has been an eye-opener for debt MF investors. These events busted several myths regarding MF and investors now understand that even debt funds can be risky. So, it becomes important to review your debt investments and have a properly articulated debt MF portfolio. Here is how you should go about creating your debt MF portfolio.
Understanding risk
Risk is one of the crucial things that people usually ignore. While deciding whether the said investment is suitable for you or not, you must understand its underlying risk. Also, you need to assess your risk appetite. There are two major risks that you will face while investing in debt funds. One is the interest rate risk and the other is the credit risk. Usually, interest rate risks lead to a reduction or appreciation of the value of the instrument with a change in interest rates. It is inversely proportional to the value of the instrument. For instance, if the interest rate falls, then the value of that instrument rises and vice versa. On the other hand, the credit risk is something that results from a change in the issuer’s credit profile. An instrument, having a high credit rating, is usually safe while the one, with a low credit rating, is less safe. Hence, you must know the kind of risk a debt fund has and keep your risk appetite. This will help you to choose a suitable product for you.
Diversification
Diversification is important not only in equity but also while investing in debt. You should never keep all your eggs in one basket. Similarly, while investing in debt, you should not just follow the fund with the highest returns but also diversify it across the categories to de-risk your portfolio. You can consider diversifying your investment in liquid or money market funds (cash), high-rated corporate bond funds, low duration funds (medium risk), credit risk funds, and dynamic bond funds (high risk). This will help you to have a balanced debt portfolio.
Duration
While investing in debt MFs, the duration is one of the things that matter a lot. This can be checked by looking at the modified duration or Macaulay duration of the fund. If the fund's duration is high, this means that the majority of the fund’s assets are invested in a long maturity period and vice versa. This will help you to align funds depending upon your requirement. For example, if you wish to withdraw funds in 3 years, then you should invest in funds with Macaulay or a modified duration of 3 years or less.