How Should NRIs Select Debt Mutual Funds in India?
In pursuing stability and returns, NRIs delving into Indian debt mutual funds should prioritize understanding fund objectives, credit quality, and duration to match their investment horizon and risk tolerance, ensuring a prudent allocation aligned with their financial objectives.
March 14, 2024
7 mins

Debt mutual funds are among the most popular investment options for non-resident Indians (NRIs) who want to invest in India. Debt mutual funds invest in fixed-income securities such as government bonds, corporate bonds, treasury bills, commercial papers, and money market instruments. They offer several benefits, such as regular income, capital preservation, tax efficiency, and liquidity.

However, not all debt mutual funds are suitable for every NRI investor. Various debt mutual funds differ in risk-return profile, maturity, and portfolio composition. Therefore, it is important for NRIs to select the right debt mutual fund that matches their investment goal, tenure, and risk appetite.

What are Debt Mutual Funds?

Debt mutual funds are funds that invest in debt securities. Debt securities are instruments that pay the investors a fixed or variable interest rate. The interest rate depends on the debt security's credit quality, maturity, and market conditions. The value of debt securities changes with the changes in interest rates and credit ratings.

Debt mutual funds are classified into different categories based on their maturity and portfolio composition. The Securities and Exchange Board of India (SEBI) has defined 16 categories of debt mutual funds, which are:

  • Overnight Fund: These funds invest in debt securities that mature in one day. They have the lowest risk and return among debt funds.
  • Liquid Fund: These funds invest in debt securities that mature in up to 91 days. They have low risk and return and high liquidity.
  • Money Market Fund: These funds invest in money market instruments that mature in up to one year. Money market instruments are short-term debt securities that are highly liquid and low risk. These funds have moderate risk and return.
  • Ultra Short Duration Fund: These funds invest in debt securities with a Macaulay duration of 3 to 6 months. Macaulay duration measures the sensitivity of the fund’s value to changes in interest rates. These funds have low to moderate risk and return.
  • Low Duration Fund: These funds invest in debt securities with a Macaulay duration of 6 to 12 months. These funds have moderate risk and return.
  • Short Duration Fund: These funds invest in debt securities with a Macaulay duration of 1 to 3 years. These funds have moderate risk and return.
  • Medium Duration Fund: These funds invest in debt securities with a Macaulay duration of 3 to 4 years. These funds have moderate to high risk and return.
  • Medium to Long Duration Fund: These funds invest in debt securities with a Macaulay duration of 4 to 7 years. These funds have high risk and return.
  • Long Duration Fund: These funds invest in debt securities with a Macaulay duration of more than 7 years. These funds have the highest risk and return among debt funds.
  • Dynamic Bond Fund: These funds invest in debt securities of varying maturities and durations. They can change their portfolio composition according to market conditions and interest rate movements. These funds have high risk and return.
  • Corporate Bond Fund: These funds invest at least 80% of their assets in corporate bonds. Corporate bonds are debt securities issued by companies to raise funds. They have higher interest rates and higher credit risk than government bonds. These funds have moderate to high risk and return.
  • Credit Risk Fund: These funds invest at least 65% of their assets in corporate bonds rated below AA. These bonds have higher interest rates and higher credit risk than higher-rated bonds. These funds have high risk and return.
  • Banking and PSU Fund: These funds invest at least 80% of their assets in debt securities issued by banks, public sector undertakings (PSUs), and public financial institutions. These securities have lower credit risk and higher liquidity than corporate bonds. These funds have moderate risk and return.
  • Gilt Fund: These funds invest at least 80% of their assets in government securities. Government securities are debt securities issued by the central or state governments to finance their fiscal deficit. They have the lowest credit risk and moderate to high interest rate risk. These funds have moderate to high risk and return.
  • Gilt Fund with 10-year constant duration: These funds invest in government securities with a constant Macaulay duration of 10 years. These funds have high-interest rate risk and moderate return potential. These funds have moderate risk and return.
  • Floater Fund: These funds invest at least 65% of their assets in floating-rate debt securities. Floating rate debt securities are debt securities that have variable interest rates that are linked to a benchmark rate, such as the repo rate, MIBOR, or LIBOR. These securities have lower interest rate risk and moderate credit risk. These funds have low to moderate risk and return.

How to Select the Right Fund?

The selection of the right debt mutual fund depends on the following factors:

Investment Goal

Your investment goal or objective helps determine the right fund, for example, income generation, capital preservation, etc. Different types of debt mutual funds are suitable for different investment goals.

For example, your investment goal is income generation. In that case, funds that pay regular dividends or interest, such as liquid, ultra-short duration, low duration, money market funds, short duration, corporate bond, credit risk, and banking and PSU funds, will be suitable.

If your investment goal is capital preservation, then funds with low risk and stable returns, such as overnight, liquid, ultra-short duration, low duration, and money market funds, will be suitable.

Tenure

medium-term, or long-term investment tenure. And depending on your tenure, you can pick a suitable debt mutual fund.

For example, if your investment horizon is less than 1 year, then funds with low maturity and low risks, such as overnight, liquid, ultra-short duration, low duration, and money market funds, are suitable.

If your investment horizon is between 1 to 3 years, then funds with moderate maturity and moderate risks, such as short-duration, medium-duration, corporate bond, banking and PSU, and floater funds, are suitable.

If your investment horizon is over 3 years, then funds with high maturity and high risks such as medium to long duration, long duration, dynamic bond, credit risk, gilt, and gilt funds with 10 year constant duration are suitable.

Thus, matching the fund’s duration with your investment duration before selecting a debt fund is important.

Risk Appetite

The risk appetite is your willingness and ability to take risks in debt mutual funds. It can be low, moderate, or high. Different types of debt mutual funds have different risk levels.

For example, if your risk appetite is low, funds with low credit risk and low-interest rate risks, such as gilt, overnight, liquid, ultra-short duration, low duration, money market, and banking and PSU funds, are suitable.

If you have a moderate risk appetite, then funds with moderate credit risk and moderate interest rate risk, such as short duration, medium duration, corporate bond, gilt, gilt funds with 10 year constant duration, and floater funds, are suitable.

If you have a high-risk appetite, then funds with high credit risk and high-interest rate risks, such as medium duration, medium to long duration, credit risk, are suitable.

Fund Specific Parameters

Apart from the above factors, some fund-specific parameters can help you compare and evaluate different debt mutual funds. These parameters are:

Historical Performance

Analysing the debt fund’s performance (returns) over 1, 3, and 5 years helps you gauge its success in the diverse market and interest rate conditions. 

You must compare the returns with the category averages and benchmark indices. This helps evaluate a fund's consistency and reliability. Look for funds that have consistently outperformed their peers and benchmark. 

However, it's crucial to note that past performance doesn't guarantee future returns, and historical performance shouldn't be the sole criteria while shortlisting a debt mutual fund.

Expense Ratio

The expense ratio of a debt mutual fund is the annual fee charged by the fund house for managing the fund. It includes the management fee, administrative fee, marketing fee, distribution fee, and other operational expenses. 

The expense ratio of a debt mutual fund can vary from 0.1% to 2.25%, depending on the type and size of the fund. 

You must compare the expense ratios to assess the cost efficiency of a fund. Lower ratios may indicate better returns for the same risk.

Fund Manager

The fund manager of a debt mutual fund plays a significant role in the fund’s performance. The choice of debt securities determines how well the fund may perform. 

A manager with a strong track record, experience, expertise, and reputation can enhance fund returns and stability. Proficiency in debt market dynamics, interest rates, credit ratings, and macroeconomics further aids effective portfolio management.

Exit Load

Exit load is the fees charged by the fund house during redemption or switching fund units, expressed as a percentage of the NAV. It reduces the net returns for the investor. You must opt for funds with minimal or no exit load. 

In contrast to equity funds, debt funds typically have lower exit loads. For instance, redeeming a debt fund within 90 days might incur an exit load of 0.5%.

Size of the Fund

The size of the fund of a debt mutual fund is the total amount of assets under management (AUM) of the fund. It indicates how big or small the fund is in terms of its market presence and influence.

For some categories of mutual funds, AUM size really doesn't matter. A fixed-income bond fund should be able to generate consistent returns, regardless of its size. 

Thus, do not consider the size of the fund in isolation; consider it in relation to the fund’s investment approach.

Asset Management Company

The Asset Management Company (AMC) sponsors and manages the fund, ensuring performance, regulatory compliance, and investor service. 

You must opt for a fund associated with a respected AMC with a good brand, long-standing history, substantial assets, a good research team, and dependable customer support.

Comparison Table

Debt Mutual Fund Information
Type of Debt Mutual Fund Risk Ideal Investment Horizon
Overnight Fund Low 1 day
Liquid Fund Moderate Up to 3 months
Ultra Short Duration Fund Moderate 3 to 6 months
Low Duration Fund Moderate 6 to 12 months
Money Market Fund Moderate Up to 1 year
Short Duration Fund Moderate 1 to 3 years
Medium Duration Fund Moderately High 3 to 4 years
Medium to Long Duration Fund Moderately High 4 to 7 years
Long Duration Fund Moderate More than 7 years
Dynamic Bond Fund Moderate Varies
Corporate Bond Fund Moderate 3 to 5 years
Credit Risk Fund High 3 to 5 years
Banking and PSU Fund Moderate 3 to 5 years
Gilt Fund Moderate 5 to 10 years
Gilt Fund with 10-year constant duration Moderate 10 years
Floater Fund Moderate 1 to 3 years

Conclusion

Investing in Indian debt mutual funds as an NRI offers regular income, capital preservation, and liquidity. However, they also have various risks, such as credit, interest rate, and liquidity risks.

Choosing the right debt fund requires careful consideration of factors like investment goals, tenure, and risk appetite. After investing, you must regularly review and adjust your portfolio according to market conditions. 

Navigating the investment process can be overwhelming, especially without the necessary expertise and time. Hiring an investment advisor (iNRI) can assist in identifying and managing the right funds. 

At iNRI, you can invest in Indian markets through seamless KYC, curated portfolios with cross-border tax support and repatriation.  We ensure compliance with regulatory norms and the Foreign Exchange Management Act (FEMA). 

Explore our curated investment themes that align with your goals, or consult with us to find the ideal fund for your investment objectives.

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