FIVE Key Things to Look For While Selecting a Debt Fund
08 Dec 2022
Investing in debt funds is just as important as investing in equity funds to give you a well-diversified portfolio. Debt fund is less volatile compared to equity fund and has the potential to provide steady income / return.
The debt fund universe is large with multiple categories such as liquid funds, medium duration, credit risk fund, corporate bond fund etc. To help you choose the multiple debt fund options, here is a quick primer.
Key Factors while selecting the right debt fund
1. Credit Rating of the fund
The credit rating of a debt fund’s portfolio is a pointer towards the credit risk and quality of the fund. A higher credit rating implies a less risk of default in the fund. The ratings vary from AAA to D with AAA being the highest rating and D being the lowest as per its credit worthiness.
2. Yield to Maturity (YTM)
Yield to Maturity (YTM) indicates expected return (before expenses) of the debt fund if its underlying investments are held till maturity, assuming no change in the portfolio. Investors should compare YTM across peer funds and choose the ones with the higher YTM assuming all other factors remains same.
3. Modified Duration
Modified Duration measures the change in price of securities due to change in the interest rates. Higher the modified duration of a fund, greater is its sensitivity to interest rate movements. Ideally investors should match their investment horizon with the modified duration of the fund.
4. Portfolio Diversification
The major risk in a debt portfolio is the default risk. When the fund is diversified across various debt companies, the impact of default by any one portfolio company on the overall fund value is reduced to a great extent due to diversification.
5. Peer comparison
Like other fund categories, debt funds must be evaluated based on their performance, any historic default by Portfolio Company’s vis-à-vis the peer group. This helps identify performers / laggards, although it’s strictly not indicative of future performance.
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