BackInvesting in a debt mutual fund? Check these 3 parameters
Liquid funds are useful for short time horizons up to 3 months while those with 1-3 year horizons may want to look at short duration or corporate bond funds
PremiumMUMBAI: Before investing in a debt mutual fund, always check for three parameters. You can use these parameters to narrow down your list of funds, following which a deeper analysis can help you fine-tune your selection. These parameters are available on monthly factsheets of mutual fund houses or third party data aggregators such as valueresearchonline.com.
Before you get down to fund selection, take note of your risk appetite and time horizon. For instance, liquid funds are useful for short time horizons up to three months while those with 1-3 year horizons may want to look at short duration or corporate bond funds.
1.Yield-to-maturity (YTM)
The YTM of a debt mutual fund will tell you what kind of pre-tax return you can expect from the fund, provided certain assumptions are met. Deduct the expense ratio from the YTM in order to get a more accurate indication of returns. For example, if the YTM of the debt fund is 6% and the expense ratio is 1%, your actual yield becomes 6%-1% = 5%. YTM only holds good as a return indicator if certain variables hold constant. For instance, if the credit rating of the debt paper held by the fund gets downgraded, you may not get the YTM.
2.Modified Duration (MD)
The modified duration of a debt mutual fund is a measure of its sensitivity to interest rates. A debt fund’s NAV varies inversely with interest rates. An MD of 1 broadly implies that the portfolio will lose 1% of its value if interest rates rise by 1%. An MD of 3 implies a 3% hit if interest rates rise by 3%. The higher the MD, the higher is the sensitivity of the mutual fund to interest rate movements.
3.Credit Rating
The portfolios of mutual funds are released every month and are available on the website of the fund houses. Typically these will also give you the break-up of the portfolio in terms of credit rating. Debt paper which is rated AAA has the highest level of safety. However, the fund may also hold lower-rated paper such as AA, A, or even BBB. Check the extent of such lower-rated paper and your comfort with it. Certain categories of debt funds such as corporate bond funds have to invest at least 80% of their assets in paper rated AA+ and above. On the other hand, credit risk funds, for instance, have to hold the lower-rated paper under Sebi rules.
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