August 11, 2017

Sreekanth B

Reasons Why We Invest In Debt Oriented Mutual Funds

Why should we invest in debt oriented mutual funds instead of Fixed deposits?

In India, most of investors are conservative and thus invest their liquid money into fixed deposits. In fact there is great need to provide awareness about alternate products which provide better returns and are also very safe & very less risky. Debt oriented fund is a great alternative to Fixed deposits right now. It is a product which constitutes govt. Debt papers and corporate debt papers.

To collect funds both govt. and corporate issue debt papers or bonds. They provide specific interest on these papers. Duration of these papers can be both short-term and  long-term. Most important thing about it is that these papers are trad-able. Government securities, also known G-sec are less risky as compared to corporate papers. Trading price of these papers is also the function of interest rate changes.

One should understand how he can take benefits from interest rate cycles. Prices of bonds have inverse relation with interest change. If interest rates come down then the prices of bonds go up and vice-versa. Also, longer the maturity period/duration of bond higher will the impact on price change. Let’s try to understand the impact of interest rate change on price in very easy manner with one simple example. Say, Govt. issues a debt paper at INR 1,000 with annual interest rate of 8% with maturity of 10 years. In next few weeks if interest rate falls by 0.25% or 25 basis points then the bond price should also shift to the level where it will get 7.75%. Due to this adjustment price of bond will increase to INR 1,017. So the fall of 0.25% interest rate gives you the capital appreciation of 1.7% and you will also get 8% returns annually on the investment paid.

India is currently going through the face where Inflation levels have come down, thus actions will be taken to strengthen GDP growth. Declining phase of interest rates has started and interest rate will further fall in coming period. Right now the repo rate is 7.75% and 10 year govt. sec yield is 7.70% approximately.

As interest rates are in declining phase one should invest in high duration government securities or GILT funds. GILT funds invest only in government securities. So the risk of loosing money is even lesser than banks. If interest rates fall by 100 basis points by year end and which is expected then GILT funds can easily give 15% return. These investments are very safe as they are not related to stock market.


Also, if one holds these funds for more than three years then he gets tax benefits on the income/return generated. If investments made under these funds are for more than three years than tax on the income generated will be taxed at 20% after indexation irrespective of tax slab. For example, if one gets annualised return of 10% & inflation is 7% then tax will be 0.6% (20% of 3%), but in FDs return is added to your income and is taxed accordingly to your tax slab. For example, if your tax slab is in 30% range then, in FDR giving 10% annualised return, you will get just 6.91% return in hand after taxation.

GILT funds have also performed very well last year as shown in table and it may continue for next two-three years till the interest rate cycle reverses. So its time to accept and invest alternates of traditional products to get good returns.

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