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Banking and PSU Debt Funds – Definition, Benefits and Should You Invest in Them?

Highlights

  • Want to invest in bonds and other debt securities of banks and PSUs?
  • You can do so by investing in Banking and PSU debt funds - Read this post to know more about these funds

Debt funds invest in debt securities such as corporate bonds, money market instruments, commercial paper, certificate of deposit, treasury bills and government securities. Different types of debt funds invest for varying maturities or duration of these securities. So, there could be a debt fund investing in securities maturing in a day, month, year, three years and more.

Categories of debt funds are classified based on their maturity profile and the type of securities they buy in the portfolio. Banking and PSU funds are a type of debt fund, let us understand more about these funds.

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What are Banking and PSU Debt Funds?

As the name suggests, Banking and PSU funds are open-ended debt funds that invest at least 80% in debt securities of government banks, PSUs (public sector units) and government-owned/run financial institutions. All government-owned banks, PSU enterprises issue bonds and other debt securities in the debt market to raise funds. These securities are bought by mutual funds under this fund.

The objective of these funds is to deliver steady returns with a good quality portfolio. This portfolio is of good quality since all government banks and PSU enterprises have the best credit metrics and have a high credit rating, mostly AAA which is the highest rating for a corporate bond. Good credit quality means that these debt securities have the least probability of default.

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All the government-run organizations are backed by the government of India, so there is more trust and comfort to lend as against private sector enterprises. Of late, there have been some instances where private companies have defaulted on interest payments leading to a NAV erosion and less or negative returns from some debt funds.

This has led to higher investor interest in Banking and PSU debt funds, which are perceived to be safer. Like all other funds, these funds have their own benefits. Let us understand them.

Benefits of Investing in Banking and PSU Funds

Returns – These funds are among the best performing category of debt funds in the last year. The average returns of all funds in this category have been around 11%. These funds have done well due to a reduction in interest rates which has led to an increase in bond prices. In the next couple of years, this performance might not repeat but still these funds will deliver better returns than most other debt funds.

Volatility – These funds are less volatile as compared to other open-ended debt funds, so one can expect steady returns

Risk – These funds do not have credit risk but they do carry an interest rate risk. An increase in the interest rate will lead to a fall in bond prices, thereby lower returns. However, the risk in these funds is much lesser than other open-ended debt funds, which carry both interest rate risk and credit risk.

Portfolio Quality – The portfolio quality in this fund is top-notch with best government-owned companies and PSU bank bonds being the constituents of the portfolio.

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Should You Invest in Banking and PSU Funds?

Banking and PSU debt funds are suitable for people who are looking to invest with a time horizon of 2-3 years and are aiming for higher returns than liquid funds. If you want your debt investment to be completely risk-free, you should invest in overnight or liquid funds only.

It is ideal to invest for at least 3 years so that you can avail indexation benefits and would be liable for a long term capital gain tax. Please note if you withdraw before a year from a debt fund, STCG (short term capital gain tax) is applicable which is calculated on a person’s tax slab.

These funds have good credit quality, offer steady returns, low volatility and are safer than other open-ended duration based debt funds such as short-term, medium-term, long duration and gilt funds.

We recommend investing in Banking and PSU funds in the current scenario if you are looking for a debt fund that beats liquid fund returns. You should have a 2-3 year time horizon in mind while investing in these funds.

To know the five best performing Banking and PSU funds to invest, you can read another post of ours-Five Best Performing Banking and PSU Debt Funds.

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