Conservative Investing: The Appeal Of PSU Debt Funds

While investing in mutual funds, individuals often maintain diverse financial goals and aspirations. Some are drawn to the potential for high risk and high rewards that equity funds offer, while others gravitate towards the stability of Debt Funds. Among the choices within the debt fund category, PSU debt funds have been attracting attention. But, the moot question arises: Are PSU debt funds suitable for conservative investors? Vardan Pandhare explores. 

In the lively world of finance, where market fluctuations and economic uncertainties can test the nerves of even the most experienced investors, the search for safe and secure investment avenues is paramount. For riskaverse investors seeking stability and consistent returns, PSU debt funds have emerged as a beacon of hope, offering a haven amidst the storms of the market. 

Essence of PSU Debt Funds
PSU debt funds are a unique breed of mutual funds that primarily invest in debt securities issued by public sector undertakings (PSUs). PSUs, the backbone of the Indian economy, are renowned for their financial strength, impeccable track records, and unwavering commitment to fulfilling their obligations. This inherent solidity translates into a lower risk profile for PSU debt funds, making them a sanctuary for risk-averse investors seeking a steady stream of income. 

In India, the financial landscape is constantly evolving, presenting both opportunities and challenges for investors. While the potential for high returns is enticing, steering the complexities of the market can be daunting. For risk-averse investors seeking stability and consistent returns, PSU debt funds have emerged as a compelling option. Banking and PSU funds are debt funds that lend only to banks and public sector companies. The high quality of borrowers means the risk of default is very low. 

Understanding PSU Debt Funds
PSU debt funds, as explained above, invest in debt instruments issued by public sector undertakings (PSUs) in India. PSUs are government-owned companies that play a crucial role in the Indian economy, ranging from banks and financial institutions to energy and infrastructure providers. As a result of their strong government backing and solid financial track records, PSUs are considered to be relatively low-risk borrowers. 

Banking and PSU debt funds rank high among mutual fund choices, particularly for investors with a conservative risk tolerance. When constructing portfolios for these open-ended debt funds, fund managers predominantly include the Maharatna and Navratna companies as these typically carry substantially lower risk profiles.
The key attributes of PSU debt funds include: 
■ Around 80 per cent of the assets in banking and PSU debt funds are invested in debentures, government bonds, certificates of deposit, and similar instruments.
■ Asset management companies (AMCs) offering these mutual fund schemes typically maintain at least an AAA– credit rating.
■ These open-ended funds are characterised by low risk due to their investment focus on debt securities. 

Key Takeaways
1. The funds have varying AUM, with some being significantly larger than others, which may affect their liquidity and flexibility in fund management.
2. Over the past year, most funds have delivered returns of around 7-8 per cent. However, there is some variation in performance.
3. The two-year and three-year returns generally range from 5-6 per cent, showing relatively consistent performance over these periods.
4. For the five-year and ten-year timeframes, most funds have returned around 7-8 per cent, indicating relatively stable performance over the long term.
5. Year-to-date (YTD) returns are around 6 per cent for most funds, signifying consistent performance in the current year. 

In general, the funds have provided relatively stable and predictable returns over different timeframes. However, investors should consider their specific investment goals and risk tolerance when choosing a fund from this category. ICICI Prudential Banking and PSU Debt Fund and Aditya Birla Sun Life Banking and PSU Debt Fund have the highest AUM, indicating that they are among the largest funds in this category 

Key Takeaways
1. On a YTD basis, banking and PSU funds have returned 5.45 per cent, which is competitive with most other fixed-income funds categories.
2. Banking and PSU funds offer a balance between risk and return, with relatively consistent performance over various timeframes.
3. Credit risk funds have high short-term returns, but may not be as stable over the long term. 4. Gilt funds provide stable long-term performance, particularly over five and 10 years. 

Suitability of Banking and PSU Funds for Conservative Investors 
For those contemplating an investment horizon spanning 2-3 years or even five years, banking and PSU funds emerge as a pragmatic choice. Their moderate risk profile, in contrast to most other funds, makes them a relatively stable investment option. Furthermore, these funds can offer solidity not only to conservative investors but also to those with a moderate to aggressive risk profile. Banking and PSU funds are particularly apt for investors with these qualities: 
■ Moderate Risk Tolerance: Owing to their limited exposure to debt market fluctuations, these funds are an attractive option for risk-averse investors.
■ Return Potential: While presenting a somewhat higher risk, these funds tend to outperform conventional choices like fixed deposits, thus providing an alternative for bank investments.
■ Liquidity and Credit Quality: Banking and PSU funds primarily invest in AAA– rated debt instruments. This not only ensures superior credit quality but also enhances liquidity, thereby establishing them as a relatively stable option in accordance with one’s financial objectives. 

Limitations of Banking and PSU Debt Funds
Banking and PSU debt funds are renowned for their relatively low risks, given their substantial investments in debt instruments from public sector entities and banks. These institutions benefit from the backing of the central government, rendering these fund schemes considerably secure compared to equity funds. Nonetheless, as with any investment, there exists a trade-off between the returns accrued and the associated risks. 

Here are some limitations of these funds that investors should bear in mind before venturing into these investments: 
1. High Net Asset Value (NAV): Owing to the low-risk nature of PSU debt funds, they experience significant demand in the market. Investors frequently opt for these securities to offset the overall risk in their portfolios. This heightened demand can lead to a higher cost of investment in the funds, potentially burdening the investor financially.
2. Modest Returns: Typically, debt instruments yield lower returns when compared to equity investments. The portfolio of a PSU and banking debt fund primarily consists of securities from Large-Cap companies, offering limited diversification opportunities. Consequently, prices tend to remain relatively stable, resulting in modest profits.
3. Short Investment Tenure: Banking and PSU funds are best suited for shorter holding periods, typically ranging from 1-3 years. 

Steps to Choose the Right PSU Debt Fund When it comes to selecting the most suitable PSU debt fund, it’s essential to take into account various critical factors: 

■ Fund Objective - Start by comprehending the fund’s primary objective – whether it aims to generate income, preserve capital, or achieve a combination of both. Ensure that the fund’s goal aligns with your specific investment objectives.
■ Credit Quality- Assess the credit quality of the PSU debt instruments held within the fund. Prioritise funds that predominantly invest in highly-rated PSU bonds to enhance stability and minimise credit-related risks.
■ Fund Performance - Dive into the historical performance of the fund across different timeframes. Look for consistent returns and make comparisons against relevant benchmarks and peer funds to gauge the fund’s overall performance.
■ Fund Manager Expertise - Investigate the experience and track record of the fund manager. Seek a manager who possesses expertise in managing debt funds and a deep understanding of the PSU bond market.
■ Expense Ratio - Take into consideration the fund’s expense ratio, as lower expenses can positively impact your long-term returns by reducing the overall cost of investment.
■ Fund Size and Liquidity- Examine the fund’s size and liquidity. Larger fund size and higher liquidity suggest a better ability to handle redemption pressures and facilitate smoother transactions, ensuring optimal investor experiences.
■ Risk Factors - Gain a thorough understanding of the inherent risks associated with PSU debt funds, including interest rate risk and credit risk. Evaluate your own risk tolerance and select a fund that aligns with your comfort level.
■ Fund House Reputation - Factor in the reputation and credibility of the mutual fund house responsible for managing the PSU debt fund. Opt for a fund house with a strong track record and prudent risk management practices to instil confidence in your investment choice.
■ Scheme Details - Scrutinise the scheme documents meticulously to grasp the fund’s investment strategy, asset allocation and any specific investment constraints it may have. 

Advantages of Banking and PSU
Funds Banking and PSU funds offer several benefits to investors, making them a popular choice in the financial landscape. These advantages include: 

1. Liquidity: One of the primary advantages of these funds lies in their liquidity. Investors can easily convert their investments into cash without significant waiting periods or penalties. This flexibility becomes especially valuable in situations where unexpected expenses arise, providing a means to quickly liquidate investments without incurring substantial losses. 
2. Moderate Risk: These funds feature shorter investment durations, reducing their exposure to prolonged market volatility experienced by longer-term investments. By primarily investing in banks and public sector undertakings, they align with institutions known for their relative stability. The public sector nature of many of these entities adds an extra layer of comfort. Furthermore, their preference for high-quality debt instruments, especially those with AAA ratings, helps minimise associated credit risks. 
3. Potential Returns: While no investment can guarantee returns, banking and PSU funds have historically demonstrated the potential to outperform traditional savings options, particularly in a declining interest rate environment, albeit with a relatively higher risk. For investors seeking returns beyond those offered by savings accounts or fixed deposits, these funds provide a viable alternative, albeit with a slightly elevated risk profile. In addition to interest earnings, these funds also offer the possibility of capital appreciation. When interest rates decrease, the value of the underlying securities may rise, delivering additional returns to investors. 

PSU Debt Funds’ Taxation
With the recent amendment outlined in the Finance Bill of 2023, capital gains originating from debt mutual funds, including PSU debt mutual funds, will undergo a distinct taxation treatment. These gains will be exclusively categorised as short-term capital gains and subsequently merged with your taxable income, subject to taxation at your applicable Income Tax slab rate. Short-term capital gains tax is triggered when debt fund units are divested within less than three years from the initial purchase date. In such instances, the resulting proceeds are subject to taxation per the individual investor’s applicable tax slab rate. For instance, investors falling within the highest tax bracket would face a tax rate of 31.20 per cent comprising a base rate of 30 per cent and an additional 4 per cent cess. 

Conclusion
Banking and PSU funds present a well-balanced proposition, combining stability with the potential for returns. These financial instruments seamlessly integrate attributes that address the requirements of investors in pursuit of both stability and potential profitability. While they are not entirely risk-free, their distinctive design and framework render them an appealing choice for conservative investors seeking an intermediary balance between the tried-and-true stability offered by fixed deposits and the return potential associated with more assertive investment avenues.