Structuring the right debt portfolio

Mutual fund investors need to concentrate on various developments around them so that they are abreast of the various changes that are taking place. Often many of them believe that it is just the equity portion of their portfolio that needs regular attention because there are lots of developments here.

This is not correct because such efforts are also required for the debt portion of their mutual fund portfolio. It is also essential that every investor has the required mix of debt and equity so that they are able to achieve the desired goals in a strong manner.

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Return of various categories of debt schemes ( as on 4 Nov, 2009)
Category	1 year	6 months
Liquid	5.2	1.9
Short term	10.4	2.4
Income schemes	9.8	1.0
Gilt	7.4	-0.8
Monthly income plan	17.0	7.0
Source: www.valueresearchonline.com

Debt portfolio

The debt portion of a mutual fund investors' portfolio consists of those schemes that have a predominant investment in debt instruments. The growth in these investments will occur when there is a rise in the value of the debt securities that are held by the scheme and traded in the debt market.

There is a wide range of options available for the investor when it comes to the debt area and this range from the very short-term where there are liquid schemes to long-term income funds that invest in bonds and corporate paper that is of longer maturity.

There are also gilt schemes that invest their portfolio in government securities only and even monthly income plans that have a majority investment in debt and a small part in equities.

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Current scenario

The current scenario is a tough one for debt mutual fund investors because of the fact that there are no obvious routes among the various options that can result in strong immediate gains.

The current situation is one where adequate liquidity in the debt market has led to a fall in the yields. The yield is nothing that the amount investors will earn on these instruments. Currently overall interest rates for all debt instruments are also low because of adequate liquidity and low inflation.

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However, there is now a growing expectation that the current situation might not continue for long and soon as inflation rises there will have to be a tightening of the monetary policy by the central bank. This is most likely to result in the interest rates heading upwards and hence this could pose a different set of challenges in the days ahead. While liquid schemes have earned an average return of 5.2 per cent in the last one year, the figure for gilt schemes is 7 per cent and income schemes at around 9 per cent.

High returns especially for the longer duration options from now on look difficult as higher interest rates can lead to a fall in the net asset value of these funds.

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Taking action

Investors who are looking at the mutual fund route for the purpose of their debt investments would do well to take action right from this moment. It will be vital for a lot of them to use the mutual fund route because direct debt options like fixed deposits have witnessed a fall in the interest rate with the highest rate for 3 years and above in the range of 6-7 per cent for many banks.

There is a major challenge in this entire situation since the movement of interest rates and the value of the bonds is in an inverse ratio. This means that if the interest rates fall then the value of the bonds rise.

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The opposite happen when the interest rates rise and the value of the bonds fall and consequently the value of the net asset value of the funds holding this as an investment reduces.

In such a situation, a probable rise in the interest rates has to result in a situation where the investor does not have a large exposure to long-term debt in their portfolio. Further there has to be some plan to earn returns from this part of the portfolio.

This calls for a mixed strategy to be adopted by the investor in their quest. The first thing is to shift their money to the short-term instruments where there is a lesser impact of the rise in the rates. If they want they can choose a liquid scheme or even a short-term scheme. In a liquid scheme the returns earned for some time period might be less, but at least this will not result in any negative impact to the portfolio.

Once the rates start rising then the investor should look out for an option that will help them lock in to the interest rates for a slightly longer period of time. This is the time when fixed maturity plans would be ideally suited for the investor.

They will lock in the returns for the investor for the specified time period or duration of the scheme as long as the investor holds the scheme till maturity. The highest rate might not be possible as it is difficult to predict the peak but the investor can ensure that they are earning a return higher than inflation when they decide to make the investment.

A part of the amounts available with the investor should be set aside and this can then also be used for the purpose of earning returns when the cycle turns. This means getting in a long-term debt scheme like an income scheme or a long term gilt scheme when the interest rates are high.

When the reverse happens and the interest rates along with inflation start to drop then there will be a position where the value of the investments of the investor starts rising and this can result in quite some good returns coming in with a lesser amount of risk.

Arnav Pandya is a Chartered Accountant and a management graduate from IIM Bangalore with a specialisation in Finance. He is also a Certified Financial Planner with experience of over a decade in the field of personal finance.

The views expressed in the article are the author's and not of Sify.com.

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