A Brief on Debt Mutual Funds

Market regulator Securities and Exchange Board of India (Sebi) has initiated new rules to make debt mutual funds comparatively less risky and force greater diversification. 

The new framework will put a cap on the investment of a mutual funds scheme, which should not be more than 10% of its net asset value (NAV) in debt and money market securities rated AAA issued by a single issuer. In the case of AA rated, the exposure should not exceed 8%, while in the case of A and below-rated companies, it should remain at 6%.

Debt mutual funds, which generate returns by lending an investor’s money to the government and private companies, have emerged as a preferred asset class due to higher portfolio yields on account of past interest-rate hikes by the Reserve Bank of India (RBI). 

As compared to equities or stocks, debt mutual funds remain a less risky investment proposition. 

Certain terminologies such as yield-to-maturity (YTM), accrual, and mark-to-market (MTM) should be considered before investing in debt mutual funds.

The YTM obtained on a debt fund is the total annualised return of all the instruments in the portfolio, provided it is held till maturity. 

Similarly, returns from debt mutual funds come from two components: accrual and mark-to-market.

Accrual pertains to the interest that is accrued or added to the NAV of the fund, every day. The interest pay-out on the instrument could be once annually or half-yearly. However, every day, proportionate interest is added to the NAV of the fund, for each instrument in the portfolio. The higher the YTM, the better, as the level of interest accrual is higher.

MTM relates to the movement of the debt mutual fund’s performance in proportion to the movement of the underlying bond market. In case bond prices rise, the returns calculated from the NAV movement will be positive to that extent and vice-versa.