Best Debt Mutual Funds to invest in 2019 India

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Usually every year I write a post related to my choices of equity and debt funds. However, I was delayed this time to write a post on my choices of Best Debt Mutual Funds to invest in 2019.

As you may be aware of now that there were a lot of issues happening in Debt market of India and Globe. Recommending debt funds turn to be riskier than recommending the equity funds.

It is mainly because we all feel debt funds are safer than equity funds. However, if you did not analyze the risk properly, the debt funds may be riskier than the equity funds.

Why I have to invest?

Before proceeding further, let us understand the basics of investment. I am repeating this again and again for the benefits of all investors. I repeated this in my earlier post of “Top 10 Best SIP Mutual Funds to invest in India in 2019“.

Before a BLIND investment, it is always best that you must know the reason for your investment. Hence, before jumping into investment read what I am sharing below.

You must have a proper Financial Goal

I noticed that many investors simply invest in mutual funds just they have some surplus money. The second reason may be someone guided that mutual funds are best in the long run compared to Bank FDs, PPF, RDs, or even LIC endowment product.

If you have clarity like why you are investing, when you need the money and how much you need money at that time, then you will get better clarity in selecting the product. Hence, first, identify your financial goals.

You must know the current cost of that particular goal. Along with that, you must also know the inflation rate associated with that particular goal. Remember that each financial goal to have its own inflation rate. For example, education or marriage cost of your kid’s is different inflation that the inflation rate of household expenses.

By identifying the current cost, time horizon and inflation rate of that particular goal, you can easily find out the future cost of that goal. This future cost of the goal is your target amount.

I have written a separate post on how to set your financial goals. Read the same at “Financial Goals – How to set before jumping into investing?”

Asset Allocation is MUST

Next step is to identify the asset allocation. Whether it is a short-term goal or long-term goal, the proper asset allocation between debt and equity is a must. I personally prefer the below asset allocation. Remember that it may differ from individual to individual. However, the basic idea of asset allocation is to protect your money and smoothly sail to reach the financial goals.

If the goal is below 5 years-Don’t touch equity product. Use the debt products of your choice like FDs, RDs or Debt Funds.

If the goal is 5 years to 10 years-Allocate debt:equity in the ratio of 60:40.

If the goal is more than 10 years-Allocate debt:equity in the ratio of 40:60

While choosing debt product, make sure that the maturity period of the product must match your financial goals. For example, PPF is best debt product. However, it must match your financial goals. If the PPF maturity period is 13 years and your goal is 10 years, then you will fall short of meeting your financial goals.

Return Expectation

Next and the biggest step is the return expectation from each asset class. For equity, you can expect around 10% to 12% return. For debt, you can expect around 7% return expectation (pre tax).

When your expectations are defined, then there is less probability of deviating or taking knee-jerk reactions to the volatility.

Portfolio Return Expectation

Once you understand how much is your return expectation from each asset class, then the next step is to identify the return expectation from the portfolio.

Let us say you defined the asset allocation of debt:equity as 30:70. Return expectation from debt is 7% and equity is 10%, then the overall portfolio return expectation is as below.

(70% x 10%) + (30% x 7%)=9.1%.

How much to invest?

Once the goals are defined with the target amount, asset allocations is done, return expectation from each asset class is defined, then the final step is to identify the amount to invest each month.

There are two ways to do. One is a constant monthly SIP throughout the goal period. Second is increasing some fixed % each year up to the goal period. Decide which suits best to you.

Hope the above information will give you clarity before jumping into equity mutual fund products.

How many mutual funds are enough?

How many mutual funds do we have? Is it 1, 3, 5 or more than 5? The answer is simple…you don’t need more than 3-4 funds for investing in mutual funds. Whether your investment is Rs.1,000 a month or Rs.1 lakh a month. With the maximum of 3-4 funds, you can easily create a diversified equity portfolio.

Having more fund does not give you enough diversification. Instead, in many cases, it may create you portfolio overlapping and leads to underperformance.

Why we invest in Debt Mutual Funds?

There are basically two reasons for it. The first one is that your goal is too short in nature (like less than 5 years). Hence, you can’t enter into equity mutual funds.

The second important reason for investing is to diversify your investment in other asset class as per the time horizon of your goal. Hence, you invest part of your investment in debt funds as diversification and also to make sure that the volatility in the equity market is subdued in debt.

Hence, I always go for Short-Term, Ultra Short Term or Short Term Gilt rather than Income Funds, Dynamic Funds or Long Term Gilt Funds.

Points to understand before investing in Debt Mutual Funds

Credit Risk-

Debt Mutual Funds invest in treasury bills, government securities, Certificate of Deposits (CDs), Commercial Papers (CPs), bonds, money market instruments and many more. The credit quality of these underlying instruments is measured in terms of ratings.

Usually higher the ratings lead to lower the return or risk. It is a misconception among many that credit risk refers to the risk of default by the bond issuing entity. However, the truth is something different.

There is a possibility that the credit rating of a bond or instrument the fund is holding may change at any point of time. Let us say ABC Debt Fund holding the bond of XYZ which is rated as AAA by credit rating agencies (highest rating).

It does not mean that this rating is permanent. It may change at any point of time if the company XYZ’s finance changes.

Hence, never be in a misconception that credit rating refers to default risk and also credit rating of a bond will NEVER CHANGE.

The classic example is the downgrade of DHFL.

Modified Duration-

It is a measurement of a bond’s sensitivity to movements in interest rates. It is usually measured in years. For example, if debt mutual fund with the modified duration of 3.1% means if there is a 1% interest rate movement then the fund will undergo the movement of 3.1%.

Hence, higher the modified duration means higher the interest rate risk.

Average Maturity-

A debt fund portfolio usually consists of a number of bonds where each could have a different maturity date. Maturity is the time period remaining before which a bond comes up for repayment by the issuer. Average maturity is simply the weighted average time left up to the maturity of the various bonds in a portfolio.

Higher the average maturity greater the interest rate risk of a debt fund.

Exit Load-

Some category of funds will charge you exit load. Hence, you have to be careful while selecting the funds and the conditions apply regarding the load structure.

Taxation-

Remember that Equity Funds and Debt funds are taxed differently. Hence, you must understand the taxation part as well before jumping into investment. I tried to explain the same in the below image.

The rate of taxation is as below for the current FY.

Also, the current DDT rates for Mutual Funds is explained in the below table.

For a detailed taxation rule of Mutual Fund, refer my post “Mutual Fund Taxation FY 2019-20“.

Best Debt Mutual Funds to invest in 2019

A lot of things changed from the article I wrote in 2018 to today. SEBI came up with Recategorization of the Mutual Funds, some default issues like DHFL or Zee.

Because of all these, we have to think twice before we choose funds in the debt category. Hence, I will restrict my suggestion towards the few fund categories only.

Best Debt Mutual Funds to invest in 2019-Overnight Fund

This is the new category of debt fund which came into the picture after the SEBI Recategorization. These funds buy debt papers or instruments for a DAY. Hence, the risk is almost ZERO. These funds are suitable to those who are parking the money for a day and above. As I said, RISK is completely NIL. However, the returns also not so high.

Do keep one thing in mind that if you look at the fund performance of these overnight funds in some star rating companies like valueresearch, the returns of over one year or more are not pure overnight funds but the older version of the funds.

Like L&T Cash Fund turned now L&T Overnight Fund and UTI G-Sec Fund turned to be UTI Overnight Fund. Hence, be cautious in choosing the funds by just looking at the return part.

My choices of two funds in this category are as below.

ICICI Prudential Overnight Fund-Direct-Growth

L&T Cash Fund-Direct-Growth

How much you can expect the returns from these funds? If you are actually looking for returns, then never choose this category. Because these funds are meant for safety rather than returns.

Best Debt Mutual Funds to invest in 2019-Liquid Funds

As I said above, due to debt paper issues and a lot of bad things in the debt fund category, I am suggesting the below funds in Liquid Funds category.

Liquid Funds are suitable to those, who are looking for investment for a few months to more. Even though there is a possibility of credit risk, but it is lower than other categories of debt funds. Returns may be a bit higher than the overnight funds.

My choices of Liquid Funds are as below.

Quantum Liquid Fund-Direct Growth

Parag Parikh Liquid Fund-Direct Growth

The reason behind choosing these two funds is that they predominantly invest in Government securities, where the default risk is NIL.

Best Debt Mutual Funds to invest in 2019-Ultra Short Term Debt Funds

Ultra Short Term Debt Funds are bit riskier than the Liquid Funds. Because they Investment in Debt and Money Market instruments such that the Macaulay duration of the portfolio is between 3 months – 6 months.

Hence, if your holding period is more than a year, then use such category of funds. My choice in this category is as below.

Franklin India Savings Fund-Direct-Growth

Franklin India Ultra Bond Fund-Super Institutional Plan-Direct-Growth

Last year, I have recommended UTI Ultra Short Term Debt Fund. However, the way they played by throwing credit rate risk in air, I stayed away from recommending that product now.

If you are looking for low risk Ultra Short Term Debt Fund, then choose Franklin India Savings Fund.

Best Debt Mutual Funds to invest in 2019-Medium Duration

These are the funds where the investment is in Debt and Money Market instruments such that the Macaulay duration of the portfolio is between 3 years – 4 years.

Hence, you prefer such funds if you are ready to take a risk and your time horizon of holding is beyond 5 years or so.

My choice in this category is as below.

Franklin India Income Opportunities Fund-Direct-Growth.

Best Debt Mutual Funds to invest in 2019- Debt-Corporate Bond

These categories of bond funds invest their portfolio of a minimum investment in corporate bonds- 80% of total assets (only in highest rated instruments).

These are meant for high risk-taker. However, the definition is in generic, I suggest you to relook into the portfolio of the fund before you choose this fund category. Always stick to top-rated instruments. Do remember again that ratings may change at any point of time. Hence, you have to be very cautious in dealing with portfolio ratings.

My choice of fund in this category is as below.

Franklin India Corporate Debt Fund-Direct Growth.

Best Debt Mutual Funds to invest in 2019- Debt-Credit Risk

As the fund category itself suggest the risk, I personally avoid such play by investing in these categories of the funds. Fund definition as per SEBI Recategorization is “Minimum investment in corporate bonds- 65% of total assets (investment in below highest rated instruments)”.

However, if your holding period is more than 5 years or so and ready to take the high risk (the meaning of high risk differ from person to person), then you can experiment with this fund category.

My choice of fund in this category are as below.

Franklin India Credit Risk Fund-Direct-Growth.

Do remember that your risk-taking ability by investing in such funds may go for a toss if the credit risk issue happens in a series of the holdings of the fund.

Best Debt Mutual Funds to invest in 2019- 10 Yrs Gilt

These are the funds which invest the minimum investment in Gsecs- 80% of total assets such that the
Macaulay duration of the portfolio is equal to 10 years.

Hence, touch these funds only if your holding period is more than 15 years or so. The only advantage of these categories of funds is that there is no default risk. However, they are highly sensitive to the interest rate movements. Hence, be cautious while investing in such categories of the funds.

My choice in this category is as below.

SBI Magnum Constant Maturity Fund-Direct-Growth

ICICI Prudential Constant Maturity Gilt Fund-Direct-Growth.

You notice that the one-year returns of such category of funds is around more than 15%. The reason is the falling interest rate. But it does not mean they are safe and will generate the same fantastic returns for the future.

Best Debt Mutual Funds to invest in 2019- Arbitrage Funds.

Arbitrage Funds are the type of funds where the fund manager uses the arbitrage opportunity available in cash and derivative market to generate the returns. For taxation purpose, these categories of funds are treated as equity funds. Hence, many use arbitrage funds over debt funds.

However, after the recent SEBI Recategorization, the definition of Arbitrage Funds changed a lot and SEBI defined Arbitrage Funds as “Scheme following arbitrage strategy. The minimum investment in
equity & equity related instruments65% of total assets”. Hence, these funds may hold the 35% in debt format, which may be riskier if you are unable to identify where the fund invested remaining 35%.

My choices of the funds in this category are as below.

ICICI Arbitrage Fund-Direct-Growth

UTI Arbitrage Fund-Direct-Growth

There are other categories of the funds also in debt fund categories of mutual funds. However, they are meant for AMCs and advisers to garner the AUM. Hence, I am not looking into those categories of the funds.

I personally suggest sticking to Bank FDs, RDs, PPF, EPF, Overnight Funds, and Liquid Funds in debt part of your portfolio.

The complete list of my choice of funds is as below.

Disclosure:- Do remember that these days credit risk or default risk may hamper on any type of fund category. Hence, before jumping into an investment, make sure that you understood the risk involved in the above-recommended funds.

Also, if there are any changes in fund style of the portfolio or the holdings of the fund, then you can to take a watch on the portfolio.

I preferably suggest using Bank RDs, FDs, PPF, EPF, VPF, Overnight Funds, and Liquid Funds to all my clients to manage their complete debt portfolio. In fact, from last few months, I stopped suggesting any Ultra Short Term Debt Funds also. Hence, be cautious with your decision before choosing the above funds.

Refer my other posts related to Mutual Funds 2019:-

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