One should invest in debt funds after finding answers to the three questions – who is the borrower, what is the period of the loan, and what are the earnings?
Understanding the borrower – It is essential to ascertain the creditworthiness of the borrower, irrespective of whether the borrower is your friend or a company or debt fund. It is based on the credit rating or the guarantor. The higher the score, the more secure is the fund.
Understanding the tenure of the loan – The date of maturity, when will we receive our money is necessary.
Understanding the earnings – Whenever we make any investment, it is essential to know the return on the amount invested.
A debt investor is conservative, looking for a fund that provides the best possible income without compromising security.
A high-quality debt fund is Bharat Bond and SDL Index fund which fulfils all the three conditions:
- In both funds, the borrowers are AAA PSUs. Various State governments issue State Development Loans (SDLs), managed by the RBI.
- The funds have defined maturity, and the funds are returned on maturity like April 2023, April 2025, April 2026 and April 2031.
- The returns depend upon the current yield to maturity.
Other benefits or uncertainties involved in investing in debt funds are:
Taxation – The income received on redemption is treated as capital gains. Indexation benefits are provided on the debt funds if the investment is held for more than three years. Indexation is a process where the cost of investing increases which reduces the capital gains, ultimately decreases the tax liability (20%).
Liquidity – The liquidation of funds can be done before the maturity date as they are open for redemptions daily.
Transparency – In the case of ETFs and Index Funds, the underlying borrowers are disclosed on the website daily and weekly, respectively.
Rule-based selection – The selection of borrowers is according to regulations or the underlying Index, which define the dos and don’ts to be followed while investing.
Uncertainties – Inflows and outflows of funds during the tenure will affect the fund returns. In case of any delay or default, the uncertainty will rise. Bharat Bonds and SLD Index are invested in AAA PSUs and SLDs which addresses the problem of uncertainty.
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