When it comes to providing stability to their portfolio and earning higher returns than traditional instruments like fixed deposits (FDs), business owners look forward to debt funds. As they invest in fixed-income instruments like bonds, treasury bills, commercial papers, etc., they offer stable returns and are immune to market volatility.
Having said that, they are not completely risk-free. It’s essential to know the associated risks with them for prudent business money investment. Let’s understand the various risks that debt funds are subjected to.
Risks Associated With Debt Funds
- Credit Risk
Credit risk refers to the risk that the bond issuer will default on its payment obligations. When you invest business money in debt funds, you are exposed to the credit risk of the bonds held by the fund. If one or more of the bonds in the portfolio default, the value of the mutual fund can decline leading to losses.
To minimise this risk, ensure to:
- Check the credit quality of the bonds held by the fund. Funds with a higher proportion of high-quality bonds are less likely to experience defaults and, therefore, less credit risk.
- Keep an eye on the bonds’ credit ratings so that you can identify the risk beforehand if there’s any drastic change in the ratings of the underlying bonds.
- Invest in funds with a strong credit research team who can identify the potential risks and avoid bonds issued by issuers with a weak credit profile.
2. Interest Risk
Interest rate risk is the risk associated with changes in interest rates that can affect the value of fixed-income securities. When interest rates rise, the prices of fixed-income securities fall, and vice versa. Debt mutual funds are exposed to this risk as they hold a portfolio of fixed-income securities with different maturities and yields.
To keep this risk to the minimum, ensure:
- To invest in debt mutual funds with a shorter duration of underlying securities. The shorter the duration, the less sensitive the fund is toward changes in interest rates.
- To explore funds with a flexible mandate which allows them to change the portfolio’s duration based on market conditions.
Additionally, keep an eye on interest rate movements and adjust investments accordingly. If interest rates are expected to go up, consider investing in funds with a lower duration and flexible mandate.
- 3. Liquidity Risk
Liquidity risk refers to the risk that arises when a fund cannot meet its obligations due to shortage of liquidity in the market. In other words, it is the risk of not being able to sell a security at a fair price when it is needed. This can lead to a situation where you may find it difficult to access your money when needed.
To mitigate this risk, ensure to:
- Invest in debt funds with high credit quality and a good track record of managing liquidity risk.
- Choose funds with a diversified portfolio which can reduce the impact of liquidity risk on the fund’s overall performance.
Conclusion
A thorough analysis of debt mutual fund options before investing can help you mitigate these three primary risks associated with debt mutual funds. With the right approach, you can significantly bring them down and make the right choice.
Disclaimer: Mutual funds are subject to market risks, please read all scheme-related documents carefully.
The content of this blog is not intended to serve any professional advice or guidance and Shootih takes no responsibility or liability in whatsoever manner for any investment decisions made by the readers of this blog or other blogs. Readers should seek independent professional advice before making any investment decision based on the information provided on this website.
