Know the risks involved with debt fund schemes; all explained in brief

When you want to invest in a particular instrument, it is necessary to understand the risks involved in it to take an informed decision. In case you are planing to invest in debt funds, then you should know about the risks associated with this particular mutual fund instrument. Zee Business' Swati Kumari gives you an insight into this.

There are primarily three types of risks associated with debt funds - interest rate risk, credit risk and liquidity risk.

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Increase or decrease in interest rates can have an impact on your returns. Usually when the economy is doing well and markets are going up, the interest rates move up, while in market downturns, there is a negative movement.

Debt funds put money in bonds where interest rates and price of bonds move in opposite directions. If interest rates are high, the value of bonds go down and vice versa. Does that mean that all Debt funds have interest rate risks? The answer is yes, but the degree of risk varies. The long term maturity funds will have a higher interest risk. For example interest rate risks are high in gilt funds. Gilt funds invest in government securities whose maturity is between medium and long term.

Interest rate risks are minimum in overnight funds and liquid funds as their maturity period is small.

Another risk is the credit risk. The schemes with high credit ratings are considered to be safer than lower rating schemes. The credit ratings are given by rating agencies. A scheme with AAA scheme is considered to be the best. These rating change from time-to-time.

Government schemes or corporate bonds have higher ratings.

The third type of risk is liquidity risk. If the debt schemes one invests in can be easily sold or purchased, it is considered to have a lower liquidity risk. The biggest example before the investors is of Franklin
Templeton which had to shut six schemes because it was unable to sell the schemes at the time of redemption. The ratings of these funds have come down.

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So, while you are investing in schemes, always look at the portfolio of the scheme. You should know the concentration of the portfolio and see which securities have the maximum exposure.