Personal finance

Banking And PSU Debt Mutual Funds Carry Low Credit Risk, But Should You Invest In Them Now?

Banking & PSU Debt funds are quite popular, with many investors preferring to park their money in such schemes. But in the sea of debt fund options available, does your portfolio need this category? Here’s help.

Funds in the category are required to invest at least 80 percent of their assets in money market instruments issued by the banks, PSUs (public sector undertakings) and other public financial institutions (PFIs). And since these entities (PSUs and PFIs) are either backed by the government (sort of quasi-sovereign guarantee) or are heavily regulated (Banks by RBI), the default credit risk is reduced by a significant extent.

As a result, this category is generally perceived to be a comparatively safe one.

Preferred investment durations

Generally, fund managers prefer short to medium duration instruments for building the portfolio of these funds. But occasionally, they may also invest in longer duration instruments if they have a favourable outlook on future rate scenarios.

On the face of it, the rule of ‘investing minimum 80 percent in instruments issued by the banks, PSUs, PFIs’ seems like a tight definition to work with. But it’s actually not. There are some flexibilities available:

-One is that the category does not define the portfolio duration. And that’s big flexibility. Theoretically, the fund’s average portfolio maturity profile can range from a few months to several years! This allows the managers to play with the duration cycle as per their discretion. Consequently, this also brings the interest rate risk into the forefront, depending on how the rate cycle is being played by the manager.

-Another big flexibility (and risk in a way) is that it is completely silent on the credit quality of the portfolio. Agreed that major investments are in banks, PSUs, etc., which have low credit-risk and have high credit ratings. But we all know that all PSUs aren’t exactly that risk free as they might seem and as for the credit ratings, they can be downgraded suddenly in the future. So, that is something to keep an eye on.

-Also, there is no restriction at all on the remaining 20 percent of the portfolio. The manager can venture outside the ‘Banking & PSU Debt’ space and into private and corporate papers, G-secs, etc. too.

Should you invest in Banking & PSU Debt Funds?

Yes, you can. In my view, this category works best if you are investing for at least 2-3 years or longer.

But it will eventually depend on your risk appetite, time horizon and other existing debt components of your existing portfolio. Things may differ for each investor when this category is combined with schemes of other debt fund categories.

Here are a few pointers to help you decide:

-If investing for zero to 1-2 years, you can skip this category without a problem. Simply have a higher allocation to ultra-short/low duration/money market debt funds.

-If investing for 2-5 years, then you can have a small allocation to this category. Other components in your debt portfolio can be low / short duration / etc.

-If investing as part of long-term portfolio for five-plus years, then you can have a medium allocation to this category. Other components in your debt portfolio can be short duration / corporate bond / gilt funds / dynamic bond funds, etc.

-If you are a conservative investor, then stick to schemes having a higher allocation to AAA-rated banking/PSU papers and those with a shorter maturity profile as they further reduce the interest rate risk.

-If you have a slightly higher risk appetite, you can consider funds in this category with a slightly longer maturity profile. Though not advisable as it can backfire big time, some adventurous risk-takers also look at what the fund manager does (to enhance returns by higher risk-taking) in the 20 percent portfolio part where there are no restrictions.

In general, you can combine the Banking-PSU fund with other suitable fund categories depending on your requirements and timeframe.

Not funds are Alike

Different Banking PSU funds have different portfolio compositions and duration profiles. No two are the same. So, before picking one, make sure you check actual portfolios to get some idea about the duration profile and the embedded risk in the fund’s portfolio.

And unless you are a seasoned investor with a large portfolio, don’t be too greedy and fall into the high-yield trap. Avoid funds that (within the 20 percent limit that they have the freedom to play with) have high exposure to papers rated below AA+. One adverse credit event can make you pay dearly.

Stick to large AUM funds of relatively large AMCs with good track records (MC30 recommends a few. Check them here). If in doubt, consult your investment advisor on how to fit this fund in your portfolio.

Generally, fund managers prefer short to medium duration instruments for building the portfolio of these funds. But occasionally, they may also invest in longer duration instruments if they have a favourable outlook on future rate scenarios.

Source: https://www.moneycontrol.com/news/business/personal-finance/banking-and-psu-debt-mutual-funds-carry-low-credit-risk-but-should-you-invest-in-them-now-7823271.html

Donovan Larsen

Donovan is a columnist and associate editor at the Dark News. He has written on everything from the politics to diversity issues in the workplace.

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