3 Debt Mutual Fund Investment Myths to watch out for

The last year has been a tough one for debt fund investors who, buoyed by AMFI’s “Mutual Fund Sahi Hai” campaign, shifted into them from traditional investments in hordes. If you’re considering making a debt mutual fund investment, here are three myths you should watch out for.

Income Funds generate income

The term “income fund” has misled many an investor to falsely believe that this category of the fund is geared to generate a monthly income. Resultantly, many investors are disappointed when they fail to do so. In reality, income funds are a named so because they are category of debt fund that generates returns mainly by accruing the “incomes” from their underlying bonds. In other words, they rely less on the capital gain, and more on the regular coupon pay outs being made by the issuers of the securities within their portfolios. Don’t invest into income funds with the expectation that they’ll be providing you with an income on a regular basis. In fact, by choosing the dividend option in these funds, you’ll be paying a tax of 28.33 percent at source, which is an extremely tax inefficient way of generating an income.

GILT Funds are low risk in nature

GILT Funds or G-Sec funds invest their moneys into government securities, and this often misleads into believing that they are low in risk. This is an incorrect assumption, though. Although it’s a fact that GILT securities have very low default or credit risk (zero, on paper), their prices are actually very sensitive. G-Sec yields can fluctuate heavily depending upon changes in interest rates a country’s fiscal position. For instance, if the RBI were to raise interest rates, yields would go up and the prices of G-Secs would fall, thereby impacting the NAV’s of GILT oriented funds negatively. Here’s a case in point: when S&P downgraded India’s sovereign ratings in 2009, GILT fund NAV’s sank like a stone! In fact, most GILT funds have given a negative return since the start of 2018, and the 1-year return from most of them has been below 2%.

FMP's provide a guaranteed return

FMP’s or “Fixed Maturity Plans” are a type of close-ended debt fund that invest money into bonds, with the intent of holding them to maturity. Since they do not sell any bonds prior to their maturity, they eliminate interest rate risk, and purely retain the default risk or credit risk. Due to the word “fixed” being present in their names, FMP’s have led many investors to believe that they provide a “fixed” or guaranteed rate of return. However, this isn’t true FMP’s returns can fluctuate if any paper within their portfolio defaults – which is a possibility, since they mainly invest into AA rated bonds. Until 2010, fund houses could release data on “indicative yields”, which were, as the name suggests, an indicative return that the FMP could provide, if none of the bonds in its portfolio defaulted. However, this practice was banned by SEBI in 2010, as many Advisors were misusing this information to tout FMP’s are a “Fixed Return” product.