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Banking and PSU mutual funds are popular with more conservative investors. This is because these are debt assets, which are generally safer than equity, but also because they’re backed by the government and other large financial institutions.
In this article, we’re going to explore one of the most popular kinds of mutual funds – banking and PSU funds – and understand what makes them good investments, and for whom.
What are banking and PSU mutual funds?
Banking and PSU mutual funds are funds that invest debt instruments that these companies issue to raise capital for their operations or for financing expensive projects. PSUs, for instance, are public sector undertakings in India that are controlled or owned by the government. They operate in various sectors like banking, energy, and infrastructure.
Structure of PSU and banking mutual funds
These funds, by mandate, have to invest a minimum of 80% of their funds in debt instruments like bonds, debentures, and certificates of deposit issued by banks and PSUs. These instruments typically have high credit ratings, indicating a lower risk of default. This is also the reason why these mutual funds trade some excess return for low risk compared to equity mutual funds.
The other 20% of remaining funds can be invested in other debt instruments, government securities, or cash equivalents to maintain diversification, lower risk, and manage liquidity.
Key features of banking and PSU mutual funds
Here are some characteristic features of funds that invest in debt issued by banks, government-backed financial institutions, and PSUs:
- Lower risk – Compared to other debt funds, they generally carry lower credit risk. This is because high-quality government-backed securities have a lower risk of default than corporate bonds, even though the latter might offer more attractive rates.
- Regular income – They aim to generate regular income through interest payments on the underlying debt instruments. These could be distributed coupon payments also.
- Moderate returns – Compared to equity funds, they offer moderately lower but potentially more stable returns. This is primarily because debt instruments carry less risk than equity.
- Suitable for – Banking and PSU mutual funds are suitable for investors seeking capital preservation with income generation.
Pros
There are some benefits to investing in these assets as well. For instance, the returns on these instruments might be tax-free. Investments held for over 3 years in specific types of these PSU bonds within the fund could qualify for certain deductions also.
Cons
However, there are some cons as well. For instance, while investors in these funds take on lower risk with their capital, they do not get the excess return that equity investors could. Secondly, their returns are independent of the market – which means that no matter how well the equities of these institutions perform, these mutual funds get a fixed return only. Interest rates, on the other hand, could make the value of these bonds fall, leading to interest rate risk.
Things to keep in mind
Here are some things to take note of when choosing a banking or PSU debt mutual fund:
- Investment objective – Align the fund’s objective with your financial goals and risk tolerance.
- Credit rating – Study the average credit rating of the fund’s portfolio to assess its risk profile.
- Expense ratio – This is the management fees you pay to the fund. Compare the expense ratio of different funds to choose one with a competitive fee structure.
- Past performance – Although this is not always indicative of future performance, analyse the fund’s historicals and make educated estimates of the market before investing.
Frequently Asked Questions
While these funds offer high liquidity, they are generally recommended for medium to long-term investment horizons (3-5 years or more). This is because interest rate fluctuations in the short-term could cause some volatility in returns. Thus, a medium-term horizon should be more in line with these funds’ objectives.
Banking and PSU mutual funds in India may not usually protect against inflation. This is because their returns may not exceed inflation rates in the country. To make sure you’re hedged against inflation, you might consider diversifying your portfolio with other asset classes like equity or real estate with more upside.
Yes, banking and PSU funds can be a part of a diversified retirement portfolio, particularly for individuals seeking income generation and lower volatility. However, make note that these mutual funds almost never cause capital appreciation and pay dividends only. Make sure that that aligns with your personal investing goals.
If you seek the same returns elsewhere, there are some other options too. For instance, you could explore other debt funds like liquid funds or corporate bond funds with varying risk-return profiles depending on the specific fund’s investment strategy and expected annual returns.
While the primary focus is on banking and PSU debt instruments, some banking and PSU funds may have a small allocation (up to 20%) for diversification in other sectors. This diversification might include investments in government securities or debt instruments issued by non-PSU companies. However, the core focus of these funds remains on banking and PSU debt, ensuring the majority of the portfolio aligns with the intended investment objective of the fund.