The Telegraph
Since 1st March, 1999
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Safe, sound & superior

THE CASSANDRAS HAVE already started writing epitaphs for the debt funds. Many contend that with interest rates having bottomed out, debt funds will lose their popularity.

My answer is a firm No.

Let me spell out the reasons why. Earlier, bank deposits used to give 10-12 per cent returns. But now take a look at the returns offered by bank deposits. One-year deposits in nationalised banks earns a paltry 5.5 to 5.75 per cent. This return barely covers the rate of inflation which is hovering around 4-5 per cent.

This is why investors will now have to look for better investment options. Even if a debt fund generates 2 per cent higher returns than a bank deposit of comparable tenure, it will still be a great investment option.

I have spoken a lot about the higher efficiency of debt funds but so far have only commented on the higher return potential. What then is this higher efficiency' Apart from the returns, investors also look at liquidity, safety and tax efficiency when they evaluate investment options. Let us see how debt funds fare on these parameters.

By liquidity, investors mean the ease with which they can get their money back. You can get your redemption or withdrawal deposited in your account if it is in one of the banks through which direct credit facilities are offered by most major mutual funds. This takes one to two days only. If you are in a major metro, most schemes offer redemption proceeds in 24 hours. No cause for concern here.

To assess safety, we need to look at the instruments where funds are deployed by debt funds. Most debt funds invest in government securities, corporate deposits and money market instruments. Government securities carry sovereign credit rating, which means highest quality and lowest risk of default, since these instruments are guaranteed by the government.

The corporate deposits that most good debt funds invest in either have AAA or AA rating. This means that the risk of default is low. Money market instruments are also of low risk as they are comparable to cash.

In terms of tax efficiency, the current budget has made dividends of mutual funds tax free in the hands of the investor. However, the mutual fund has to pay 12.8125 per cent tax on dividend distribution. This means that if you are in a tax bracket of 20 per cent or higher, mutual funds give better tax efficiency than bank deposits since returns on the latter are taxed at the applicable rate.

So even on these three additional parameters, debt funds come out comparable or better than bank deposits. Now you know why I called debt funds an obvious choice. I also feel that the popularity of debt funds has just started and they are destined to become the most favoured investment option for investors seeking productive, safe and sound investment options.

(The author is MD, Standard Chartered Mutual Fund. The views expressed in this article are his own).

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