Why Debt Funds Are Essential for Risk Management

Debt funds are mutual fund schemes where the portfolio mainly comprises fixed-income securities like corporate bonds, government bonds, and money market instruments. When you invest in a debt fund, you essentially lend money to governments or corporations in exchange for regular interest payments. 

The main objective is capital preservation, ensuring your money is relatively safe while generating a steady income. Let’s highlight some reasons why debt funds can be a risk management tool.

Top Reasons to Choose Debt Funds

Here are the four reasons that make debt funds a smart pick.

Diversification 

Debt funds tend to perform well in different market conditions. When added to your equity-concentrated portfolio, they help smooth out potential losses from equities during downturns, balancing the overall risk.

Additionally, debt funds often have a lower correlation with stocks, meaning that when equities underperform, your debt investments may still generate positive returns, helping to protect your portfolio.

Regular Income

You can expect regular income from your debt funds like the one offered by DSP Mutual Funds. The scheme distributes the interest income earned from its bond portfolio among the investors. Depending on the scheme, you may receive payments periodically, such as every month or quarterly.

If you prefer not to receive the interest payout, the interest income will be accrued to the fund to increase the scheme’s NAV, providing benefits at the time of redemption.

The potential for regular income is not only ideal for risk management but also makes it suitable for conservative investors.

Lower Volatility

Debt funds are not immune to volatility, but they are much less volatile compared to equity funds. You may see a decline in the NAV of equity funds when there is an increase in the unemployment rate, a negative impact on the profitability of companies in a particular sector, or any major announcement by the government that goes against investors’ sentiment.

On the other hand, debt fund volatility depends on the type of bonds in the portfolio. For example, if there is a long-term bond, it may be more sensitive to rate changes. This means its prices can experience significant swings when interest rates rise or fall. In contrast, short-term debt funds are usually stable, as they are less affected by interest rate movements due to their shorter maturity profiles.

Furthermore, the credit quality of the bonds in the scheme’s portfolio also influences volatility. Funds that include lower-rated bonds (or junk bonds) may encounter higher volatility due to the increased risk of default.

Tips to Choose the Best Debt Funds 

Consider the following parameters when deciding on the best debt MFs.

• Check the expense ratio and compare it with other debt funds. This ratio represents the fee that asset management companies charge to manage the funds. Even if there is a small difference, it can still impact your returns.

• Review the track record of the fund manager. The perfect example of a well-managed fund is one that has delivered risk-adjusted returns over time.

• There is no denying that previous performance does not guarantee favorable returns in the coming years, but it would still give you insight into how the fund performed when there was a major change in interest rates.

Conclusion

Debt funds provide much-needed stability in an otherwise volatile investment financial market. They help you diversify, preserve capital, manage interest rate risks, and offer liquidity without locking your money away for extended periods. Debt funds are a smart choice for those seeking tax-efficient and inflation-beating returns.