Are there 'safe' debt funds that may pay more than FDs? | Economic Times

Bank fixed deposits have been the favourite of most conservative investors. However, with bank FD rates falling to multi-year low, investors have started feeling anxious and looking for alternatives. Of course, these investors are looking for alternatives which offer stability and better returns. Debt mutual funds have always been seen as a good alternative but with the recent happenings in the debt space many investors have started getting apprehensive about investing in debt mutual funds. ETMutulfunds.com tried to evaluate some debt mutual fund categories to see whether they can become a good alternative for bank FDs in a low interest rate scenario.The State Bank of India’s FD rates range from 2.9% to 5.4%. Experts believe that bank FDs and debt mutual funds can’t be compared on the basis of returns alone. They have different risk and return potential. However, is there a debt mutual fund category that can come close? Based on the historical average returns, debt funds have delivered better returns than bank FDs. But debt funds can’t match the safety of FDs at all. “There are three types of risks in debt funds - credit risk, interest rate risk and liquidity risk. To choose debt funds which are close to an FD, we need to minimize all these three risks. Funds with the highest credit quality (100% into AAA rated or Sovereign bonds) and low modified duration (less than 1 year) can be a reasonably close alternative for FDs,” says Arun Kumar, Head of Research, FundsIndia.Now, how does a retail investor know which schemes meet these requirements? Many mutual fund advisors believe that corporate bond funds and Banking & PSU Funds are two categories which have minimum credit rate risk. These schemes mostly invest in higher-rated debt securities and are safer than the other categories. However, investors should know that having a AAA-rated portfolio doesn’t negate all the risk in a scheme. “All debt investors should have a conservative approach in their investments. Currently, in the debt categories one can choose high credit quality corporate bond funds and banking PSU funds with 3-year time horizon to earn comparatively better returns. Also, one can look at floater funds if they wish to reduce mark to market risk if interest rates rise,” says Rushabh Desai, an AMFI-registered mutual fund distributor based in Mumbai.Recent performance of Corporate Bond Funds:Scheme name1-year returns (%)3-year return (%)Axis Corporate Debt9.978.73ABSL Corporate Bond9.959.07IDFC Corporate Bond9.358.44 Also read: Best Corporate Bond Funds to invest in 2021Recent performance of Banking & PSU Funds:Scheme name1-year returns (%)3-year return (%)Nippon India Banking & PSU Debt Dir8.859.19IDFC Banking & PSU Debt Dir8.789.57ABSL Banking & PSU Debt8.528.86 Also read: Best Banking & PSU Funds to invest in 2021To negate the interest rate risk, investors need to look at debt funds that have securities with shorter maturity. Shorter the maturity profile, lower the interest rate risk. For example, gilt funds may be low on credit risk because they mainly deal in govt securities, they can be exposed to a lot of interest rate risk because their maturity profile is usually more than seven years. “Given our view that we are in a rising yield environment, high credit quality funds with lower modified duration is our preference at the current juncture - liquid funds, ultra short term funds, money market funds and low duration funds with high quality portfolios can be a good choice for those who want to avoid interest rate risk and credit risk to a large extent,” says Arun Kumar. Liquid funds, ultra short term funds, money market funds and low duration funds are the schemes with the lowest interest rate risk, but these schemes can also be risky. Investors have to choose schemes that have a high quality portfolio and even after that, be ready for a black swan event like the shutting down of schemes by Franklin Templeton. “If you have a three-year plus time horizon, belong to the highest tax bracket and want liquidity, debt funds are a good choice. The drawback FDs face is the lock-in period, lack of indexation benefit and expertise of the fund manager. Investors should compare the maturity profile and the post-tax yields between debt funds and FDs. Debt funds do have an edge over FDs, especially for large corpuses but FDs are important as well from a diversification point of view. If you don’t want the above and just need the security of your money with less returns, you should stick to bank FDs,” says Rushabh Desai.