Fixed income funds can be differentiated into categories on a scale of risk returns
These schemes invest in short-term money market securities, which have maturity not exceeding 60 days
Fixed income funds are often associated with safety, but this doesn’t apply to all types of fixed income funds. Here’s a look at various types of these funds and their position on a scale of risk return.
MONEY MARKET FUNDS
Known as liquid funds, these schemes invest in short-term money market securities, which have maturity not exceeding 60 days. These are meant to park funds for say, a week to 3 months. The safety comes from the fact that they invest in short-term, high-rated securities.
INCOME FUNDS
These include ultra short-term bond funds, short-term income funds, income or credit opportunities funds, and long- and medium-term income funds. These typically invest in money market securities, corporate bonds, non-convertible debentures and government securities.
Ultra short-term funds: These are the least risky in this category. Fund managers are open to invest in bonds and money market securities but average maturity of such schemes remains 6-8 months, going up to one year or more in some. The best indicator of the fund’s positioning is to see its benchmark—one mainly leaning towards a liquid index is likely to have a safer and more liquid portfolio as well.
Short-term funds: This is the next level, where average maturity of portfolios goes up to 1-2.5 years or so. Typically, residual maturity of such securities isn’t over 2-3 years. The duration risk (linked to change in interest rates) is low as most rely on accrual income. But credit risk (default or downgrade risk on lower rated securities) will depend on the portfolio.
Credit opportunity funds: Similar to short-term funds in average maturity and mix of securities (but avoid government bonds), the express interest in these is to generate higher yield via relatively lower-rated securities These are designed to maximise returns by analysing the opportunity in specific corporate bonds and yields at which they are available. The higher degree of credit risk can lead to negative returns.
Long- and medium-term funds: Riskiest in the category, these funds are meant for savvy investors. Their main objective is to build on the interest rate view (duration risk). Long-term securities with existing high rates benefit the most in a falling rate environment. These are riskier than others as high duration makes the net asset value (NAV) volatile. If the view goes wrong, you can lose capital.
GILT FUNDS
These funds only invest in government securities and come in short-and long-term categories. The risk is of duration, hence, your NAV can be volatile. There is also a risk of capital loss. While short-term gilt funds keep the risk low with average maturities of 3-4 years, medium- and long-term gilt funds’ average maturities can be much higher, 10-20 years. The duration risk in these funds can make these funds volatile in the short term leading to negative returns which at times may be sudden and sharp.
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