5 Things To Check Before Investing In Debt Mutual Funds

What is what is debt fund It is a mutual fund scheme that focuses on investment security rather than returns. Debt funds invest in highly rated government and corporate bonds.

But not all debt schemes are made equal. Ask the right questions before investing.

1. What Assets Does The Scheme Invest In?

A debt fund that promises high returns might be investing in low-rated bonds. Such bonds offer better returns but are also more likely to default.

2. Is The Asset Portfolio Diversified?

Good debt schemes spread investments across 30 to 40 companies. So, if one or two companies default, the others cushion the blow.

Avoid schemes with more than 7% exposure to a single issuer. Excessive exposure can wipe out gains.

3. What About Exposure To Companies From A Single Group?

If the parent company defaults, all group companies will take a hit. So, avoid schemes with over 15% exposure to companies from a single group.

Instead, look for more diversified schemes where the top 10 holdings comprise less than 40% of the total corpus.

4. Is The Scheme’s Rating Under Review?

Rating agencies may do this if they anticipate an upcoming credit event. It could signal that things are not okay.

Steer clear if a particular scheme’s rating is placed under review often.

5. Has The Share Price Of The Issuers Dropped?

Sharp drops in share prices may not affect bond values.

But a debt fund which has lent against shares that plunge could end up with insufficient cover for its bonds. This could affect the net asset value.

Conclusion

When investing in debt funds, don’t chase returns. Opt for schemes that are diversified and that invest in high-quality assets.

Also read:

• Behavioural finance—keeping investors’ emotions in check

• What can you learn by analysing a company’s debt profile?

• What is a liquid fund?

• Learn from the history of stock market crashes