If you have ever tried selecting a debt-based mutual fund for a long-term investment, you know it could be a daunting task. There are 59 funds in the medium and long-term bond fund category. The returns from these funds varied from -3.94 per cent to 26.60 per cent in the past one year.
But investing in a long-term debt fund could be a necessary evil, especially if you lie in higher income tax bracket. Good performing funds in this category have given over 8 per cent returns post-tax returns in the last five years, higher than bank fixed deposit. In addition, it is recommended that an investor should allocate 10 per cent of the portfolio to these funds for stability.
"The volatility of returns in these funds confuses investors. People are willing to take risk in equity for better returns but not with their debt investments," Alok Singh, head-fixed income and structured products, Fortis Mutual Funds.
Fund managers of medium and long-term bond funds try to maximise the returns by trading the securities they hold. This causes the difference in returns of bond funds.
Redemption is another reason that affects the return of bond funds. If there are redemptions, the fund manager needs to sell the securities at loss to meet these requests.
"The major investors in these funds are either high-net worth individuals, companies and financial institutions. And they do time their exit and entry depending on the interest rate movement," said a mutual fund expert.
If you are looking to invest in this category of funds keep the following things in mind before putting your money:
Track record: Look for returns of the fund over a long period of time, that is, over five years. Also check the fund's returns since its inception. "Performance over smaller tenure can be due to some calls going wrong. But a good fund manager will have better performance over longer tenure," said Singh. This also means, you should avoid new funds.
Risk appetite: The investor needs to be ready for the fluctuations of the returns and even for the investment to go negative in the short-term. For instance, the best of the funds in the past one month have delivered negative returns.
Investor base: If possible try to find out about investor base of the fund. Some funds such as Canara Robeco do not take any single application of over Rs 1 crore in their non-institutional funds. "This helps us to avoid volatile flows that affect the fund's performance," said Ritesh Jain, head-fixed income, Canara Robeco.
AMC and fund manager: Do a check on the career span of the fund manager. "The person taking care of your money should have seen the ups and downs in the debt market to take more prudent calls," said a fund manager.
Also check on the asset management company and its sponsors. Fund manager quitting can also affect the fund's performance, it is therefore, necessary to invest in an AMC that has an established track record.