MF Query Board

I am 53 years old and my debt mutual fund allocation is 60 per cent of my total mutual fund portfolio. Should I increase or decrease my exposure in the same? What is the risk associated with debt mutual funds? - Manish Pathak 

While considering asset allocation in your portfolio, your equity and debt allocation depends on your age, risk appetite, your short-term and long-term goals and life stage. Since you have not mentioned the total debt exposure of your investment portfolio as such, it is difficult to concur on your first question. But as a thumb rule in portfolio management, your exposure in equity should be 100 minus your current age i.e. 47 per cent in your case and the remainder 53 per cent should be parked in Debt Funds and debt-related securities. 

Following are the types of risks that should be considered while investing in debt mutual funds:

■ Interest Rate Risk: The market value of fixed income securities is generally inversely related to interest rate movement. Generally, when interest rates rise, the prices of existing fixed income securities fall and when interest rates drop, such prices increase. Accordingly, the value of a scheme portfolio may fall if the market interest rate rises and may appreciate when the market interest rate comes down.

■ Liquidity Risk: The ease with which a security can be sold at, or very close to, its yield-to-maturity (YTM) or actual value is referred to as liquidity risk. The market’s liquidity situation changes from time to time. Depending on market factors that affect changes in the liquidity premium associated with the bond’s price, the liquidity of a bond may alter. When there is limited liquidity, it may be more expensive to sell securities than usual. Additionally, depending on market conditions, the liquidity of any one investment in a portfolio may decline, necessitating a bigger discount at the time of sale.

■ Credit Risk: This is risk associated with default on interest and | or principal amounts by issuers of fixed income securities. In case of a default, the scheme may not fully receive the due amounts and the NAV of the scheme may fall to the extent of default. Even when there is no default, the price of a security may change with expected changes in the credit rating of the issuer.

■ Spread Risk: Corporate bond credit spreads may alter in response to shifting market conditions. If credit spreads widen, the market value of the portfolio’s debt instruments may decline, and vice versa. Similar to fixed rate securities, the value of floating rate assets may decrease if spreads over the benchmark security or index widen. Hence, it is always advisable to read the scheme information document while investing in any kind of mutual fund.

Does a children’s gift fund have any advantages over a conventional fund scheme? - Ratnali Mehta 

Children’s gift funds are mutual fund schemes that offer returns that would offer financial advantages to your children for needs such as meeting marriage expenses, future educational needs, etc. This creates long-term capital appreciation and would fall under the category of Hybrid Funds or balanced mutual funds. Children’s funds invest in a mix of stock and debt securities with the goal of generating either wealth or income. Their allocation is skewed towards equity or fixed income depending on the purpose. Based on the extent of exposure to equities, these are further categorised as hybrid debt-oriented or hybrid equityoriented funds. The category currently has a wide range of asset allocation followed by funds with equity exposure ranging from 21-98 per cent.

The key points to consider before investing in these funds include:

■ Objective of the Fund: Find out the asset allocation strategy used in the fund and the investment strategy. Factors to be looked into are whether the funds are equity-oriented or debt-oriented and the risk associated which the respective scheme.

■ Lock-In Period: These funds are subject to a lock-in of either five years or till the child attains 18 years (age of majority), whichever is earlier.

■ Documentation: To invest in a gift mutual fund, the investor must provide basic KYC documentation. The KYC documents contain information about the child and the investor i.e. the parent or guardian. Additional KYC documentation must be given when redeeming the fund or when the child reaches the age of maturity.

■ Returns: To evaluate the opportunity cost of investing in a children’s gift mutual fund, compare it to other equity funds. This helps an investor choose the appropriate mutual fund programme to generate high returns

Besides the lock-in period, which is to enable investors stay invested, it has been observed that these funds do not offer any benefit to investors relative to other categories. Hence, it is advisable to consider other pure-play equity and debt funds to have better control over the desired asset allocation and select funds with a long-term track record.