Debt fund investors or income seekers usually look for better returns than bank deposits. However, if this higher return comes at the cost of safety of capital, then it makes no sense. One excellent avenue which is safe and still offers much superior returns are a category of investments termed as Banking & PSU Debt Funds
These schemes mostly invest in bonds or debentures issued by Banking firms and PSUs. The portfolio is, therefore, made of the highest credit quality. Bonds or debentures of most PSUs carry the highest credit rating as these are owned by the government of India and enjoy quasi-sovereign status.
Some of the prominent Govt PSUs held in these scheme portfolio are NHAI, FCI, Rural Electrification Corp, NTPC, Power Finance Corp, SIDBI and NABARD, among others. Most PSUs are rated AAA or equivalent as the government ownership ensures comfort of Principal and Interest repayment.
Bonds or debentures of banking entities are rated AAA or AA depending on the tenure. These are also of impeccable credit quality. While banking and PSU funds can invest up to 20% of the portfolio in other instruments, most have invested the allocation in safe Government Bonds.
With such a high credit quality, banking and PSU funds have remained resilient even as some other schemes have taken hits from recent credit episodes. With an inherently high quality portfolio, banking and PSU funds offer much better returns (See image above) and also serve as safe haven.
Banking and PSU funds also score high on the liquidity front. The bonds and debentures of PSUs and banks boast high liquidity in the secondary market. Given that these are well traded, fund managers can easily buy and sell these bonds to capture pricing opportunities. Such opportunities arise from tactically managing the portfolio as fund managers switch between short-term and long-term maturity bonds depending on the interest rate scenario.
In a falling interest rate scenario like previous and current year, these bonds can provide significant capital appreciation, in addition to interest income. The Banking and PSU funds have benefited from softening interest rates by positioning the portfolio towards medium-term to long-term bonds.
But if you had invested in a Bank FD, such appreciation in principal over and above interest income is just not possible. Besides, as interest rates come down, when you renew the Bank FD, you will have to settle for lower interest rate slab. Hence, Banking and PSU Funds offer a big advantage to get safe returns and also benefit from falling interest rates, instead of getting worried about it!!
3. Superior Performance & Returns
These funds have stood out on the performance front. Over the past year, these funds have clocked nearly 9% returns.
This is only behind Govt. Security funds and Long duration funds which benefited the most from the down-trending interest rates.
4. De-risk the portfolio
So should you consider banking and PSU funds?
The focus on high credit quality, short-to-medium maturities and inherent high liquidity make these funds very attractive for your portfolio's debt allocation and income seeking investors. These perfectly fit the needs of an investor looking for higher returns than bank FDs, without taking added risk, an excellent choice for risk-averse investors. Debt fund investors can derisk the portfolio by parking a part of their investment allocation in these funds
5. Investment Options
In the current time when Bank FD rates have dropped significantly, Covid threatens to slow down the economy and with businesses trying to re-establish normalcy, investors will find lot of comfort in Banking and PSU funds with their investments in safe and high quality bonds. Given that further interest rate cuts are likely, these funds with higher portfolio duration are likely to do much better than FD products.
Additionally, with uncertain cash flow from businesses, there is a visible shift of big investement money from Lower credit rated (A and below) to high quality AAA rated and Govt of India (Gilts) securities. This can further enhance returns in Banking and PSU Fund portfolios due to demand - supply equation favoring such funds.
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Sethu V, Founder of Dhanayoga. I'm a Serial Entrepreneur, Management Consultant, Value Investor and Certified Investment Adviser. Connect me at http://linkedin.com/in/venkatsethu