Monday, February 12, 2007

Performance Evaluation of Mutual Funds - Delving deep for Debt Funds

Work your Way up with your Wealth building Winners! (Contd.)

Performance Evaluation of Mutual Funds (contd.)

Delving deep for Debt Funds

The process of performance evaluation of Mutual Funds discussed so far applies to Debt Funds as well. But you need to familiarize yourself with certain aspects unique to Debt Funds. I shall outline some critical points you should consider to make an educated choice while selecting a Debt Fund.

Asset allocation

A Debt Fund invests primarily in corporate debt, government securities and money market instruments. You need to evaluate the asset allocation of the Fund to gauge its volatility. For example, prices of government securities (gilts) in times of economic and political turbulence can be volatile, and this leads to higher uncertainty i.e. more risk. A well-diversified portfolio is a strong positive. The Ideal Debt Fund has 25% in gilts, 70% in corporate debt (including financial institutions) and 5% in cash/call.

Rating profile

The quality of the portfolio is of paramount importance. Look out for securities with ‘AAA’ rating, as this will reduce the credit or default risk. The Ideal Debt Fund has 60% exposure to AAA-rated securities and 25% exposure to gilts, which have a sovereign rating.

Maturity profile

You need to see the maturity breakup of the securities and look out for paper that is at the lower end of the yield curve. This is because an instrument having low maturity carries a low coupon rate and vice versa. So any change in the interest rate has less effect on the price of the instrument of low maturity than the higher one. Moreover, there is an inverse relationship between the bond prices and the interest rate, when the interest rate falls the bond prices move up and vice versa. There is no standard maturity. Depending on the interest rate view of the fund house, the fund manager increases the fund’s average maturity or shortens it mainly through the gilt route. Maturity is normally controlled through investments in gilts which are normally at the longer end while the investments in corporate debt are normally at the short to medium end. The Ideal Debt Fund has about 40% in less than 3-year paper and 35% in 4-6-year paper.

Debt Funds come with various options - short-term plans, long-term plans and so on. You should invest in the debt schemes looking at your investment horizon. For short-term horizons you should look at investing in the liquid (for a 1 month horizon) or the short term debt plans (for 1-6 months). For horizons above 6 months you should look at the debt schemes or the long term gilt schemes. Debt funds generally don’t have entry load but most of them are subject to an exit load. A good Debt Fund has an exit load of 0.25% to 0.5% if redeemed within 3 or 6 months. You should avoid a Debt Fund having a higher load structure than stated above.

As far as performance is concerned, look at the returns given by the fund over a period of time – at least over 12 months to get a fairly good idea and 36 months to judge consistency in performance. If you want to evaluate its dividend-paying track record then look at the dividend history for consistency.

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