All-Weather Best Debt Mutual Fund Portfolio 2024 – How to Create?

How to create an All-Weather Best Debt Mutual Fund Portfolio 2024? Is it possible to create a risk-free all-weather debt mutual fund portfolio?

Before proceeding further, read my earlier post “Top 10 Best SIP Mutual Funds To Invest In India In 2024” where I have provided some basics about portfolio construction. In this article, we dwell more on how to create an all-weather debt mutual fund portfolio.

All-Weather Best Debt Mutual Fund Portfolio 2024

Also, to simplify certain debt portfolio basics, I wrote few articles (will write in the future also” related to basics of Debt Mutual Funds. You can refer to the same “Debt Mutual Funds Basics“.

Before we proceed further, we must first understand why we need a debt portfolio for our investment. If you don’t have clarity on this aspect, then your debt portfolio will be more risky and cluttered than equity.

Why do we need Debt Mutual Funds?

Instead, of debt mutual funds, I may use the term why we need debt portfolio at first. As per me, the need for a debt portfolio is primarily for two purposes.

# To fund your short-term goals

If your goals are short-term in nature, then you can’t take undue risk of equity. Hence, you need a debt portfolio to achieve your financial goals. Many may ask the question that they can’t beat the inflation. Yes, but the idea is to fund your financial goals safely rather than looking to beat the inflation in all your investments of whatever you do. To clear this, I wrote an article on this aspect. You can refer to the same at “Beat The INFLATION – LIES Financial Industry Teaches You!!“.

# As a cushion for your long-term goals

For long-term goals to generate real returns (inflation-adjusted returns), we must invest in equity. However, equity is a highly volatile asset class. Hence, to reduce the volatility or to create downside protection for our portfolio, we need a debt portfolio.

If you have clarity like this, then the next steps are easy for you. However, when you chase the returns (in the debt market it is called yield), then you will end up taking a bigger risk than equity.

The next question is why you need debt mutual funds in your portfolio (especially when the taxation of debt funds nowadays is taxed as per your tax slabs). Even though taxation is like your Bank FDs or RDs, even if we assume both Bank FDs (RDs) provide the same returns as Debt Funds, due to the TDS concept in FDs will actually to a certain extent reduce your returns. In case of mutual funds, the taxation is only when you withdraw the money. Hence, I still suggest you explore debt mutual funds for your mid-term to long-term goals.

The second purpose of using debt mutual funds in your portfolio is when you still have a gap after utilizing products like PPF (for long-term goals), SSY (for your daughter’s education and marriage goals), or EPF (for retirement).

For your short-term goals, you can use Bank FDs, RDs, sweep-in FDs, or Arbitrage Funds (if you are more concerned about taxation).

Few points to understand before directly jumping and following this strategy –

# It is for your long-term goals

This portfolio strategy is for your long-term goals. Hence, follow this strategy if your goal is more than 8-10 years away. Never follow this strategy for medium-term to short-term goals.

# It is not buy and forget strategy

When I suggest an all-weather best Debt Mutual Fund Portfolio in 2024 does not mean you invest today and open your eyes after 8-10 years. Once a year or based on your suitability, you have to check the asset allocation of debt to equity. At the same time, check the fund portfolio (not performance).

# Idea of this strategy is to reduce the interest rate risk

The idea of this strategy is to balance the interest rate risk. Hence, for better clarity, you must always check and monitor the portfolio of the fund categories mentioned here.

# Idea of this strategy is SIMPLICITY

There are N number of strategies. Neither I am questioning them nor against them. My idea of sharing this strategy is more of simplicity and not to add too many funds to your portfolio.

# You have to derisk once your goal turns into short term

As I mentioned above, this strategy is for long-term goals. Hence, once your goals turn into mid-term or short-term, then you have to come out with such strategies and stick to short-term debt funds ONLY to reduce the interest rate risk.

How to Create an All-Weather Best Debt Mutual Fund Portfolio 2024 – How to Create?

You know that to a certain extent, we can avoid the credit risk or default risk. However, when you invest in debt funds (or in bonds), you can’t eliminate the interest rate risk. Only the degree varies for example – short-term debt funds may have less risk than long-term debt funds.

Hence, when I create a long-term debt mutual fund portfolio, I prefer to balance this interest rate risk by including 50% in Short Term Debt Funds and another 50% in Long Term Debt Funds.

# 50% Short-Term Debt Mutual Fund Portfolio

For short-term debt funds, I prefer either Ultra Short Term Debt Funds, Money Market Funds or Short Duration Passive Debt Funds.

a) Ultra Short-Term Debt Funds – Do remember that Short-Term Debt Funds as per SEBI means a fund investing in instruments with Macaulay duration (I will dwell on this aspect in detail in a separate post) between 3 months and 6 months. In simple, Macaulay duration is a measure of how long it will take for you to recoup your investment. Do remember that SEBI’s definition is SILENT on the quality of papers the fund has to invest. Hence, it is YOU who have to be careful in choosing the Ultra Short Term Debt Fund. Sometimes even Ultra Short Term Debt Funds may turn risky if the fund manager chases the yield. The classic example is Franklin’s fiasco (Franklin Templeton India Closed 6 Debt Funds – What Investors Can Do?“. Hence, be careful in choosing the funds.

b) Money Market Funds – As per SEBI, a money market fund means an open-ended debt scheme investing in money market instruments and also having a maturity of up to 1 year. Here, you have clarity about the fund manager’s holding as he has to invest only in money market instruments. Hence, they are bit safer than Ultra Short Term Debt Funds (but SAFEST).

c) Short Duration Passive Debt Fund – Currently only one fund is available in this category “Edelweiss CRISIL IBX 50:50 Gilt Plus SDL Short Duration Index Fund – Time To Move To Passive Debt Funds?“. By investing in such fund, you can completely avoid credit risk and default risk as the fund invests 50% in Gilt Bonds and another 50% in SDL (state government bonds). However, if you look at the portfolio, the modified duration is around 2.37, Macaulay’s duration is 2.54, and the average maturity is 2.78 years. Hence, it may be a little bit high volatile than the Ultra Short Term and Money Market Funds.

For example, in the case of Ultra Short Term Funds, the Macaulay duration should be 3-6 months. In the case of Money Market Funds (I took an example of ICICI Pru Money Market Fund), the Macaulay duration is showing as 0.32 (category average is 0.31). Hence, even though you are completely avoiding the risk of default and downgrade, it may be a little bit more volatile than the above-mentioned two categories of debt funds.

Based on your comfort, you can choose Ultra Short Term Funds, Money Market Funds or passive short duration fund (choices are limited).

# 50% Gilt Mutual Fund Portfolio

The remaining 50% of such an all-weather portfolio should be in Gilt Funds. There are two types of Gilt Funds. One is the normal Gilt Fund and another is the Gilt Constant Maturity Fund. Gilt Funds as per SEBI means “Minimum investment in G-secs 80% of total assets (across maturity)”. Hence, by investing in a normal Gilt Fund, you are to a certain extent you are avoiding 80% of default and downgrade risk. However, as the fund manager can hold “across maturity” bonds ranging from short-term, medium-term, or long-term (based on his future prediction on the interest rate cycle), they may be volatile. If the fund manager is perfect in predicting the interest rate cycle and accordingly churning his portfolio (the probability of such SKIL is rare and many times it is because of LUCK), then you are fine.

However, normal Gilt Funds are less risky than the Gilt Constant Maturity Funds. In terms of Gilt Constant Maturity Funds, the fund manager has the mandate to hold gilts such that the Macaulay duration of the portfolio should be equal to 10 years. Hence, Gilt Constant Maturity Funds are highly volatile compared to normal Gilt Funds.

For example, the average Macaulay duration of Gilt Funds is around 5.83 years. Hence, Gilt Constant Maturity funds are high volatile than normal Gilt Funds. I prefer normal Gilt Funds over Gilt Constant Maturity Funds.

What if you know when you need the money?

The above all-weather debt mutual fund portfolio is for such goals where the goals must be long-term in nature and when you are unaware of the exact need for money.

However, if you are aware of when you exactly need the money, then rather than adopting the above strategy, the simple way is to adopt the Target Maturity Funds. They act like typical Bank FDs in terms of maturity. All these TMFs have a maturity date. On that date, they will give back the money to you. However, you can enter and exit before that maturity at any point in time. The second advantage of such funds is that as of now, they are investing only in Central Govt, State Govt, and PSU bonds. Hence, you can to a certain extent avoid the credit or default risk.

The most important feature of such TMFs is that as the maturity of the funds (underlying bonds) is certain, the interest rate volatility by default will reduce as the maturity is near. You no need to move to a separate debt portfolio to reduce the volatility risk. Hence, moving to short-term debt funds due to the short-term nature of the goals is not required if you invest in such funds.

However, if are unsure of when you need the money or the suitable such Target Maturity Funds are not available in the market, then you can ignore such funds. The earlier debt funds list is available at “List Of Debt Index Funds In India 2023” for your reference.

Conclusion – The idea of sharing this post is to avoid the number of funds in your portfolio, avoid the credit/default risk, and also to manage the interest rate risk to the maximum. Be cautious while choosing debt funds. Otherwise, you may end up creating a high-risk debt portfolio which is more riskier than your equity portfolio. Note also that, the risk is everywhere. The art of investing is to manage this risk.

5 Responses

  1. Dear Basu Sir,
    Thank you very much for your detailed information.
    I would like to seek one clarification. Instead of a 50% allocation to a Gilt fund, would it be suitable to consider the Parag Parikh Conservative Hybrid Fund as an alternative?
    This fund primarily invests in State Development Bonds, offering a similar sovereign exposure of 70% compared to 80% in a Gilt fund.
    Additionally, the 10% equity allocation (Very less exposure to equity) focuses on high-value dividend-paying stocks.
    I would be grateful for your insights on this potential alternative.
    Thank you for your response.

    1. Dear Rajan,
      I prefer the fund where there is clarity and mandate to invest in high quality bonds than the fund which currently doing it and playing it safely by investing in Govt Bonds. Hence, as concern is safety, if you wish you can consider so. But I prefer a pure debt fund.

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