Want to move out of fixed deposits? Know how debt mutual funds fare

Apart from the bonds offered by the government and corporate, funds available in the debt mutual fund (MF) category are considered as a viable alternative to FDs.

With the interest rates on fixed deposits (FDs) falling below the rate of inflation, investors are losing the purchasing power of the money invested. Many of such investors are now willing to venture out of the apparent safety of FDs and want to invest in other financial instruments that provide higher returns along with safety and liquidity.

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Apart from the bonds offered by the government and corporate, funds available in the debt mutual fund (MF) category are considered as a viable alternative to FDs.

Earlier, liquid funds were the most favourite choice among the fixed-return investors due to excellent liquidity and good safety records.

However, with the Reserve Bank of India (RBI) keeping the key policy rates very low and banks and other financial institutions flush with funds, the rates of returns on liquid funds have fallen drastically, making them out of favour for retail investors.

The newly rejuvenated overnight fund category also failed to attract the retail investors due to ultra low rate of return.

Hit by a series of bond defaults, investors have also lost faith in many other categories of debt funds.

Not satisfied with FD rates? Know the risks and rewards of investing in Corporate Bonds

So, keeping the safety and liquidity issues on record, following funds may be considered by FD investors as viable alternatives.

Fixed Maturity Plan (FMP)

As FMPs invest in financial instruments with fixed maturity periods and fixed coupon rates, like FDs, investors may predict – with a fair amount of accuracy – how much maturity value they would get and when they will get it.

Disadvantages: The main disadvantage of FMPs are that they are close ended funds and hence, transactions like purchase/additional purchase, redemption can’t be made with the concerned AMCs.

Although such funds are registered in exchanges, transactions are difficult due to lack of participation.

Roll Down Strategy

Funds based on roll down strategy are open ended funds and provide good liquidity.

However, as AMCs continue to do fresh investments and liquidate the old ones as per their investment objectives, investors can’t predict the maturity value and investment duration of the underlying securities.

The easy entry and exit options also affect the valuation of funds.

Target Maturity Gilt Index Fund

The returns on Target Maturity Gilt Index Funds are generally predictable to a fair extent as the investments are done predominantly in government securities and the underlying securities mature within the targeted maturity period.

So, the risk is lesser due to the predictability on where investments are done when the instruments would mature.

Apart from the minimum credit risk and minimum duration risk, Target Maturity Gilt Index Funds offer liquidity as well as they are open ended and transactions with the concerned AMCs are allowed prematurely.

Risks

Investments in MFs are capital investments and hence are considered riskier than investments in FDs.

Target Maturity Gilt Index Funds face reinvestment risk as at the time of reinvestment after 6-7 years, coupon rate on new securities after maturity of existing securities could be lower.

Investors may also face volatility on withdrawal before the target maturity date. This may happen if new securities are issued by the government at an interest rate beyond a threshold limit.