How To Select The Best Debt Funds?
There are 4 steps to select Debt Funds:
- Select the tenure of your Investment:
The first step in selecting debt funds is knowing what is the tenure of your investment. If you want to invest for a short period, then investing in a bond which has a low duration or a low duration fund makes sense. If you want to invest for a longer time, selecting a long duration bond/fund is sensible. We will discuss the concept of duration in our later sections in the module.
Let’s suppose you selected the low duration fund.
The next question is that more than 100 funds are operating in this category, which one should we choose?
- Check Credit Ratings:
To choose the appropriate fund, we need to check every fund’s credit rating under this scheme.
Suppose you want to check the Credit Rating of Kotak Low Duration Fund,
If we go to valueresearchonline.com and type the fund’s name, we will be able to see this fund’s credit rating.
Credit Rating vis-a-vis Category:
In the above image, we can see the Average Credit rating of this portfolio. As we know SOV & AAA is the best credit rating, and this fund has invested its majority of funds in AAA or A1+ rated securities, which is why this fund might not be the best one to invest in. We will get into the details of the Credit Ratings in our later sections.
- Concentration Risk:
Now, the next question is what is concentration Risk?
Concentration Risk is the risk of investing in a single asset. For example, if you have ₹100 to invest, and you put ₹10 into a single bond, then your concentration risk is 10%.
There isn’t a rule which says what is optimum concentration risk for a debt fund.
How can we check concentration risk?
Simple, we can go to Stockedge, click on Mutual Funds, then click on Debt Securities, and then we can see all the 16 categories of Schemes which we talked about a little while ago.
Under the low duration fund, we will able to see all the funds that are categorised under this category, from there we can click on Holdings and we will be able to see the percentage of all the holdings that the fund has:
As we can see, the top holding of this fund has a concentration risk of 3.7%.
As we know, The YTM or Yield To Maturity of a bond is the total return a bond will generate if it’s held until maturity. Once we select the funds, we need to check how much return they will generate. For this, we can again visit stockedge, and click on the info of the selected fund.
Here, we can see the YTM and Expense ratio of this fund. If we subtract the YTM from its expense ratio, we will get the total return this fund will generate. For this fund, the expected return will be 5.50% - 1.9% = 3.6%. The fund with the highest return probability is the fund we should invest in.