How to evaluate Debt Mutual Funds
It's important for you to consider the
following while choosing an appropriate Debt Mutual Fund -
Stated investment
horizon
Maturity profile
Credit rating
profile
Asset allocation in
Fund Portfolio
Other quantitative
indicators
This information is available in Mutual
Fund Fact sheet's that are uploaded every month on the websites of Asset
Management Companies.
Stated
Investment Horizon..!
Debt Mutual Fund generally specify an investment horizon, for which
investors should consider investing.
This is an important parameter that is
sometimes overlooked by investors, who remain invested for long periods without
considering the market factors.
The specific investment horizon should be
looked at to aim for optimum risk adjusted returns in the debt fund.
Maturity
Profile..
It
is a graphical representation of the maturity of all holdings of the funds
portfolio. It gives an over all picture as to what percentage of the funds net
assets fall under different time frames, ranging from 6 months to 1 year to 3
years and so on.
This helps understand what percentage of the funds assets
invest in which maturity bonds, and to what extent the fund is exposed to the
interest rate risk. In a falling interest rate scenario, debt funds maintain
relatively higher portfolio maturities and vice versa.
The image above is representational
of the maturity profile of a debt fund, as presented in a mutual fund fact
sheet.
Credit Risk and
Credit Rating Profile..
Debt Mutual Funds can invest in securities with different
credit ratings, as per the schemes investment strategy. The credit rating of
the security is listed alongside its name in the mutual fund fact sheet.
These
ratings are assigned by different rating agencies and indicate the credit
worthiness of the borrower. Higher the rating, high is the creditworthiness of
the borrower, although the returns may be lower as compared to a bond issued by
an entity that has a lower rating.
The Credit profile of the debt portfolio
indicates the level of credit risk that the debt fund has assumed. A large
chunk in sovereign papers or highest rating papers implies that the fund is
taking lower credit risk.
The image above is representational of
the rating profile of a debt fund, as presented in a mutual fund fact sheet.
Asset Allocation in Fund portfolio..
This
helps investors understand the investment approach of the fund manager.
Debt
funds invest in bonds issued by different entities and investors can identify
the percentage of the fund's portfolio that is invested in the various debt
instruments like government of India bonds, state government bonds, corporate
debt, public sector undertaking (PSU) bonds, treasury bills, cash etc.
In
a fund portfolio, one can see list of instruments that the fund has invested
in. While this will vary continually with the buying or selling calls taken by
the fund manager, the portfolio can be indicative of the strategy employed by
the fund.
A
larger exposure to Government of India securities would imply a potential for
greater returns in a falling interest rate scenario (as bond prices and
interest rates are inversely related). Investments in good Corporate and PSU
bonds have the potential to earn higher interest income than the investments in
pure government of India bonds.
A certain percentage of the portfolio is also held
in cash and net current assets. This is done to ensure availability of funds to
meet the day-to-day redemptions of investors without having to sell securities
which might affect the portfolio's performance.
Other Quantitative Indicators of debt
Mutual Funds
Average maturity of the portfolio..!
This figure,
represented in day or years, gives the average maturity of all the instruments
held in the portfolio.
Duration of portfolio..!
The duration
(not to be confused with maturity) is the measure of the price sensitivity of
the portfolio to a change in interest rates. Funds with a longer duration would
be more sensitive to a given change in interest rates.
For example, if interest
rates were to go down (or up) by 1% in a month, the Net Asset Value (NAV) of Bond
fund is likely to go up (or down) by 5 per cent if modified duration of
portfolio is mentioned as 5 years.
Yield..!
The yield is a
measure of the interest income generated by the bonds in the portfolio. Funds
that invest in bonds that have a higher coupon rate would have a higher
portfolio yield. In a stable interest rate scenario, this can be considered as
an approximate measure of the returns the fund can generate.
However, in a
falling interest rate scenario, this is not a true measure of the returns, as
it does not account for trading gains that can accrue from the active buying
and selling of bonds.
The yield to maturity of a debt fund indicates the
running yield of the fund. Debt funds are total return products returning both
accrual of interest and mark to market gain or losses.
Other than above, investors must also
look at the stated investment objective of the debt fund, its positioning in
the style box, other fund features section and its performance record over a
period of time vis-a vis its benchmark.
The
points listed below, provide a snapshot of the parameters to consider while
deciding in which Debt Mutual Fund to invest.
· 1.The debt fund Portfolio gives a list of the instruments the fund
has currently invested in, indicative of its investment strategy.
· 2. Average portfolio
maturity indicates the length of time
until the principal amount of the bond is repaid.
·
3.Duration of the
portfolio indicates the price sensitivity
of the portfolio to a given change in interest rates; a measure of the fund's
volatility.
· 4. Average maturity
and duration fluctuate depending on the view
of the fund manager for flexible and dynamic debt funds. A fund with higher
maturity and duration is expected to yield better results in a falling interest
rate scenario and vice versa. This is because interest rates and bond prices
are inversely related and longer the tenure of the bond, the more sensitive it
is to changes in interest rates.
·
The yield is a measure of the interest income earned on the bonds
held in the portfolio.
· 5. The maturity profile of the portfolio can be used to understand
the composition of the portfolio.
· 6. Returns can potentially enhanced by
lowering credit quality of
the portfolio, which enhances the credit
risk. The rating profile can be used to understand the credit risk.
From www.icicipruamc.com
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