8 Step Guide to Invest in Debt Funds

I started my Mutual Fund investment journey when I was 17 years old. I had some money and the Internet. So, I started looking beyond Bank Fixed Deposits. And, I found Franklin Templeton Ultra Short Term Fund. It was giving a steady 9% per annum return at that time.

I was very much surprised because the FD Interest rate was just around 7% per annum. Moreover, I could withdraw money from this fund at any time without any penalty.

From my “research”, I concluded that Debt Funds are as secure as a Fixed Deposit, especially those Liquid and Ultra Short Term.

 

Franklin shuts its 5 Schemes

I stayed invested in Franklin Templeton UST Fund until I noticed, that those 9% returns have dropped to around 4%, thanks to Voda-Idea Fiasco. They had created a Segregated Portfolio of Holdings that could default.

After waiting for a few months, I redeemed my investment from that Fund and invested somewhere else, because I felt that something was wrong with that fund (Even I knew that Voda-Idea could default anytime because of its extremely high debt, why wouldn’t a learned fund manager notice it?).  

Thankfully, in the next few months, Voda-Idea paid back their dues. So, Franklin also gave me my money back from that segregated folio.

This year, (i guess) around February, Franklin closed that UST Scheme along with 5 others, because it was under heavy redemption pressure.

I didn’t give much heck about it until recently, when another fund, Indiabulls UST, where I had invested some money, was shut down. Actually, the AUM of this fund was just ~ 20 crore. They had only one Treasury Bill in their portfolio.

Although I knew those facts already, I wasn’t expecting Indiabulls to shut down that scheme. I had no idea that this could ever happen like I had no idea (4 years back) that a UST Debt Fund could give negative returns.

 

Investment Goal

I am not earning anything, as I don’t have a job. So, I invest in a very risk-averse manner. My investment goal is to get the most security for my Investment while obtaining respectable returns.  

Even if you want your portfolio to give more returns, always choose debt funds that have good quality assets. I believe that debt funds should do the job of providing stability to a portfolio instead of returns.

Depending upon your risk appetite, You should maintain a healthy mix of various investments (Debt Funds, Equity Funds, Fixed Deposits, PPF, Insurance) in your Portfolio.

Every investment clearly serves a purpose. If you want more returns and you understand the risk involved in Equity, then you can invest some of your money in Equity.

The basic point is to not invest in Debt Funds with an expectation of getting very high returns. The focus here should be the Security of the Principal.

 

8 Step Guide

I am still learning my way around the Mutual Fund world. So, to keep me safe, I have come up with a 8 step process for screening good quality debt mutual funds.

If you want to invest in Debt Funds, you can also follow this guide. For this particular demo, I would try to find the best Ultra Short Term Funds to invest our money.

 

Step 1 – Check Scheme Ratings

Go to the following websites and adjust the filters to get a list of UST Funds: 

1. Crisil
2. Morning Star
3. Value Research

I have filtered the following funds by matching the ratings from the above three websites:

Scheme	Crisil Rating	Morning Star Rating	Value Research Rating
ABSL Savings	4	5	5
PGIM India UST	N/A	5	5
L&T UST	4	5	3
IDFC UST	5	N/A	4
HDFC UST	3	N/A	4
Kotak Savings	3	5	4
Invesco India UST	3	5	3
SBI Magnum UST	3	5	4
BOI AXA UST	N/A	5	3
Canara Robeco UST	N/A	4	3
DSP UST	4	4	3
Essel UST	N/A	3	4

 As you may notice, it’s a pretty long list. We will trim this up as we move forward. The basic logic in this step was to match the ratings of UST Schemes across the three websites and choose funds, which have a 5/4 star rating on one website, a 5/4/3 star rating on the second website, and a 3 or above rating on the third website.

In case, we don’t find any ratings for a fund on 1 website, We would ignore that fact. But, if we don’t fund ratings for a fund on 2 websites, then we won’t include that fund in our list.

This step primarily ensures that we don’t carry forward any funds that have bad asset quality.

 

Step 2 – Check Assets Under Management (AUM)

More the assets, the better it is while investing in Debt Funds. We can use the Money Control website to check the AUM of funds that we had filtered out in Step 1.

Scheme	AUM (cr.)	Qualified for Next Step
ABSL Savings	17,294	Yes
PGIM India UST	295	No
L&T UST	2,811	Yes
IDFC UST	5,605	Yes
HDFC UST	16,433	Yes
Kotak Savings	13,559	Yes
Invesco India UST	1,034	Yes
SBI Magnum UST	14,533	Yes
BOI AXA UST	420	No
Canara Robeco UST	400	No
DSP UST	3,371	Yes
Essel UST	23	No

Now, I would filter out funds that have AUM less than 1,000 crores. You can still invest in funds that have an AUM of more than 500 crores. But, definitely stay away from funds that have AUM less than 100 crores.

So, New List is:

ABSL Savings

L&T UST

IDFC UST

HDFC UST

Kotak Savings

Invesco India UST

SBI Magnum UST

DSP UST

 

Step 3 – Fund Manager

 Now, we would check if, there have been any recent changes in the fund manager(s) of the schemes. You can use the Value Research website for this purpose. 

Scheme	Fund Manager 1	Fund Manager 2	Qualified for Next Step
ABSL Savings	2013	2014	Yes
L&T UST	2014	2020	Yes
IDFC UST	2018		Yes
HDFC UST	2018		Yes
Kotak Savings	2013		Yes
Invesco India UST	2020	2020	No
SBI Magnum UST	2013		Yes
DSP UST	2016		Yes

 I have tried to check if lone/both fund manager(s) has/have been changed in the last 12 months. So, I have filtered out Invesco India UST because both of its Fund managers have been changed in Jan 2020.

This step ensures that there is some continuity in approach and decision making of the Fund Managers. You don’t wanna become a victim of Corporate Hoch Poch, Right?

So, the new list includes the following names:

ABSL Savings

L&T UST

IDFC UST

HDFC UST

Kotak Savings

SBI Magnum UST

DSP UST

Step 4 – Portfolio Analysis

As I had mentioned earlier, my main goal is to keep my investment secure. So, this step is quite important to me. I look for funds that have maximum AAA securities in their portfolio.

I am choosing a UST and they have a Macaulay duration of 3-6 months, so, I would filter out a fund that has more than 15% AA grade securities and I won’t choose a fund if it has more than 0.5%, below-AA grade securities.

If you are investing in a fund that has a longer Macaulay duration (like Short Term Fund or Long Term Fund), then I would advise you to go with a scheme that has a portfolio consisting of 100% AAA-rated securities.

Some people may call this step an overkill because we have already checked the credit ratings in Step 1 and have already filtered out the funds which had lower ratings. But, I still go through this step to my satisfaction.

I don’t want to lose money because of some corrupt guy/girl at any rating agency who assigned a higher rating to a not-so-good fund.

Scheme	%age Securities below AAA grade	Any security below AA grade?
ABSL Savings	7.46%	No
L&T UST	0%	No
IDFC UST	0%	No
HDFC UST	0%	No
Kotak Savings	8.53%	No
SBI Magnum UST	1.32%	No
DSP UST	0%	No

 

Step 5 – Risk-o-meter Test

Risk-O-Meter is available on all major websites. Stick with low or moderately low, while investing in a UST fund.

Scheme	Risk-O-Meter Reading
ABSL Savings	Moderately Low
L&T UST	Moderately Low
IDFC UST	Moderately Low
HDFC UST	Moderately Low
Kotak Savings	Moderately Low
SBI Magnum UST	Low
DSP UST	Moderately Low

This step, in a way, rechecks our research up to this point. We have now filtered out almost all bad quality funds.

 

Step 6 – Interest Rate Fluctuation

Do Remember, this step isn’t really applicable for funds that have a Macaulay duration of up to 1 year. If you have correctly followed the above 5 steps then, your Liquid/Ultra Short Term/Low Duration Fund shouldn’t show much Interest Rate Fluctuation.

But, if you are looking to invest in Short/Long Duration funds, then you surely need to compare Modified Duration and Average Maturity across your funds. This comparison would give you an idea about the kind of interest rate fluctuation you may experience during your investment period.  

These figures (modified duration and average maturity) are available at money control as well as the Value Research website.

At times, Modified Duration or Average Maturity won’t give you an adequate idea because although the Average Maturity maybe, say 3 years, but some securities could have maturity date way farther than 3 years (say 10 years).

So, while choosing Short/Long Duration Debt Funds, you would need to be extra cautious.

 

Step 7 – Look at the Expense Ratios

Scheme	Expense Ratio
L&T UST	0.23%
IDFC UST	0.26%
DSP UST	0.29%
SBI Magnum UST	0.31%
Kotak Savings	0.32%
ABSL Savings	0.34%
HDFC UST	0.34%

The expense ratios of funds in our list vary in a small range of 0.11%, which is quite acceptable. So, we won’t filter out any funds at this step. But, if you are investing through your Distributor or you are investing in a scheme, which has a higher expense ratio differential across funds. Then this Step would help you in making the final call, as you would be able to compare the return differential with the expense ratio differential b/w funds in your list.

 

Step 8 – Understanding the Past Year Returns

Scheme	1 yr returns	3 yr returns	5 yr returns
ABSL Savings	7.12	7.67	7.95
HDFC UST	6.47	N/A	N/A
SBI Magnum UST	5.98	7.3	7.24
Kotak Savings	5.94	7.02	7.22
IDFC UST	5.72	N/A	N/A
L&T UST	5.59	6.83	7.18
DSP UST	5.53	6.46	6.92

 As they say in mutual fund advertisements, past performance doesn’t really guarantee future performance but it surely gives us an idea about what we can expect from our investment.

Since our expense ratio differential is just 0.11%, we would not compare the stats from Step 7 with those from Step 8.

But, If you compare statistics from Step 4 with those from Step 8, then you would find that Funds that have AA-rated securities in their portfolio have delivered comparatively higher returns, with an exception of HDFC UST. So, the crappier the assets in the portfolio, the more the returns.

 

Final Words

The 7 funds listed in Step 8 are probably safe to invest in and may deliver stable returns depending on the market conditions.

If I had to choose then I would split my money b/w ABSL Savings, HDFC UST, and SBI Magnum UST. This way, even if one fund house shuts down its scheme (like Franklin), I would still have my funds safe in the other two schemes.

Also, keep in mind, that this list won’t stay relevant after a few months. So, I would suggest you repeat step 4 (i.e. do portfolio analysis) every month for the funds in which you will invest your money.

If you find out that the Asset Quality of a fund is declining, then you can take the call of redeeming your money from that particular fund and investing somewhere else. 

After every 6 months, you should redo all the above-given steps and check if you need to move your money to some new place.