How to construct a low-risk debt mutual fund portfolio?

Investors who are looking for low-risk investment options often turn to debt mutual funds. These funds hold fixed income securities such as corporate bonds, government bonds or money-market instruments, thereby offering a steady stream of income to investors. However, it is important to note that debt funds are not entirely risk free.

They carry interest rate risks, inflation risks, and credit risks, which can impact the overall debt fund returns. That is why it’s important to construct a stable debt fund portfolio that balances these risks, protects your capital, and still generates returns. With that being said, here are some useful strategies to help you create a low-risk debt fund portfolio that also aligns with your investment objectives.

  1. Invest in different types of debt funds with different maturities

Investing in different types of debt funds can mitigate the risk associated with a particular type of debt instrument or issuer.

For example, you can allocate your portfolio into overnight funds, liquid mutual funds or other short term debt funds for higher liquidity with minimum risks. Also, investing in long term duration funds or gilt funds can provide higher returns but carry a higher interest rate risk because of their long-term maturity.

For a more diversified portfolio that balances risk and returns, you can include both short-term and long-term debt funds.

  1. Diversify with other asset classes

Besides debt instruments, diversify your portfolio with equity and gold, real estate investment trusts (REITs), and other mutual fund investment schemes. For example, a portfolio could include an allocation of 50% in debt mutual funds, 20% in gold, 20% in equity, and the remaining 10% in REITs. This not only reduces risk in your portfolio but also improves your overall returns as you can leverage the potential of different asset classes in different markets.

  1. AMC level diversification

Invest in multiple mutual fund schemes managed by different asset management companies or AMCs. This helps in reducing the concentration risk associated with a particular AMC. It is advisable to allocate your portfolio across at least two to three AMCs, with a maximum of five with varied credit ratings, average maturity, and fund sizes. This will provide sufficient diversification while still allowing you to closely monitor each AMC’s performance.

  1. Choose schemes with high credit ratings

Credit ratings provided by reputable agencies serve as a benchmark for the creditworthiness and stability of the bond issuer. Schemes with high credit ratings of AAA or AA present minimal credit risk, while lower-rated instruments carry higher risk of default. It is wise to select mutual fund schemes with high credit ratings to reduce the risk of default and protect your investment.

  1. Invest in dynamic bond funds

Dynamic bond funds can help you create a low-risk debt mutual fund portfolio without much effort. These funds have the flexibility to invest in different debt instruments, including short term papers to longer tenure bonds. They adjust their portfolios as per market conditions to mitigate risks and generate reliable returns.

For example, in rising interest rates, dynamic bond funds invest in short term papers whereas they may switch to longer tenure bonds when rates start falling.

Ending notes

Creating a low-risk debt mutual fund portfolio involves careful planning and analysis of many factors. Starting with a clear understanding of your financial goals, you must research different debt fund products and compare their cost structure, fund management style, and historical performance data. You can find these details in scheme related documents offered by the fund.

While critically evaluating each option, it is important to consult a financial advisor who can help you create a diversified portfolio that has minimal risk and fits your individual needs.

Comments are closed.