New to debt mutual funds? Safety apart, there are risks too

“I have invested in debt funds which are the safest form of mutual funds”, “Debt funds are usually risk-free,” or “I will never get negative returns in the Debt mutual funds” are some of the beliefs  mutual fund investors carry until reality hits them in some form of crisis.

Although it is true, that safety, quality and liquidity are some of the important aspects while investing in debt funds. The reality is that while they are safer than equity, debt funds do carry risk. Let’s debunk four most common myths related to debt mutual funds:

All debt mutual funds are the same

The Association of Mutual Funds in India (AMFI) has classified Debt Oriented Category into 16 different kinds of debt mutual fund schemes. Some of which include Overnight fund, Liquid fund, Corporate Bond fund, Credit Risk fund, Long Duration fund, and Banking and PSU fund among others.

That said, investors should understand that the objectives of different mutual funds may be different. Some schemes focus on quality, while some on returns and therefore investors should understand the various degrees of risk that may not be appropriate for them as per their risk appetite. For instance, the Credit Risk fund has the highest risk attached to it, while the Gilt fund has the lowest risk.

Debt funds are risk-free

As discussed above, different debt funds take different levels of credit risk, interest rate risk, liquidity risk, and concentration risk. All the mentioned risks should be evaluated by investors as per their risk appetite before choosing a fund.

Believing the hype

Making investments based on big names and brands may lead to crisis. Since the last year, a few popular mutual fund companies have been making headlines for their lapse in their credit risk fund schemes or downgrades in their debt security. Therefore, investors should not only look at the well-known names but should understand the fund’s past performance, fund management strategy, funds risk, and so on.

Debt funds never give negative returns

In case of credit default/downgrade happens in an underlying debt security, there may be a fall in net asset value (NAV) depending on the extent of a fund’s exposure to it. Further, a sharp increase in interest rates can also lead to a fall in the NAV of debt funds depending on the maturity profile of the debt schemes. Similarly, during the sharp increases in interest rates, even liquid funds may show negative returns during certain days.