The closure of six Franklin Templeton Debt Funds has made investors anxious. Their concern is further aggravated by the threat of job loss due to present lockdown. The equity markets have witnessed historic volatility and investors are suddenly finding themselves in a tight spot.
Debt funds form a crucial part of a diversification strategy. They cannot be written off arbitrarily. Debt funds provide significant tax benefits to the investors by way of indexation. Fixed income instruments like the fixed deposit are taxed according to the slab rate of the taxpayer. This is a big disadvantage for someone who is in the higher tax bracket. Instead of exiting debt funds, one must reconstruct the debt fund portfolio with a focus on safety.
The Franklin Templeton debacle can be attributed to the fact that the fund invested heavily in instruments with high credit risk. Credit risk funds can be termed as exotic instruments. The slight decline in the economy can affect the performance of the fund. Similarly, hybrid funds should be avoided too. In uncertain times the focus should be on the preservation of the capital. Investors should focus on debt funds that only invest in AAA-rated securities. The returns might be a tad slower, but it ensures peace of mind. Select Banking and corporate debt funds offer a considerable level of safety due to their policy of investing only in AAA-rated securities.
Not all debt funds are risky. If you have cash lying in your savings account, it makes sense to park it in the overnight fund or liquid debt funds. Not only these are considered safe, but also provide decent capital appreciation compared to a meager 2.5-3% offered by a savings account. Other fixed income instruments require a certain period of the lock-in period. Debt funds do not suffer from such limitations. Hence it does not make sense to exit the debt fund portfolio completely. The wiser strategy is to invest for the medium-term duration, say 3-5 years.
The debt mutual funds have grown exponentially in recent years. They have assumed systemic importance in the economy. A well-planned debt investment can protect the investments during historic volatility that investors witnessed a few months ago. Debt funds should form a significant part of the portfolio. For a retail investor, they are must because of limited risk profile. An all-equity portfolio can derail finances, especially during volatile times. A robust debt fund portfolio can ensure steady returns over a period of time.
While equity investments are always preferred, the very nature of debt funds is to provide an opportunity for income generation. Besides diversification, they offer ideal tax hedge due to lower taxation along with indexation benefits for long term investors. Debt funds are highly regulated hence they offer complete transparency in terms of portfolio disclosure.
To sum it up, instead of exiting the debt fund portfolio, it is recommended to restructure the debt fund portfolio. The debt fund universe is vast. It is not a DIY thing. Every investor must consult his financial adviser before investing in a debt fund. This will help him understand the risk better which in turn means better financial management.
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