Why have Debt MFs in an equity and gold portfolio?

Please pardon my ignorance, but I want to ask a basic question - is there any advantage to having Debt MF in a portfolio with Equity MFs and SGBs? I understand that equity and gold would hedge against each other.

Both equity and debt are volatile assets. Debt provides some stability and predictability to portfolio.

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The very purpose of experts asking investors to have debt mf, along with equity and sbg is for diversification and tax management.

This makes sense in a way, however, my views are slightly different.

  1. In a debt MF, your money is invested in corporates who give a fixed interest rate and hence volatility is minimized. However, my point is that, if there is a economic downturn, then these companies who have taken your money will also face the same issues. Of course, it is not possible that all companies within the debt MF will face the heat. Hence to have real diversification, the safest option is debt funds like Bharat Bond , SBG etc.
  2. I still believe that FD should be considered as this is outside the market, I do understand that there is a possibility of these banks going down, but then these banks are in fact monitored by Central Bank as well and amount of 5 lack is guaranteed. Experts do not even consider FD as they say it is tax inefficient, but then you can tax plan it well.

Feroze Aziz of Anand Rathi during the March 2020 crisis, same time when FT happened and many MF started to side pocket or did segregated portfolio used to advise that when it comes to debt MF, it would be better that investor invest in multiple MF instead of one, as if one company defaults, effect on the portfolio will be low, of course, you should ensure that the second debt MF are not investing in the same company (Should not be overlap).

Discl: I am not an expert, these are my personal views. I am biased towards FD, Postoffice and other Government backed deposit scheme. I have seen first hand the importance of FDs during the march 2020 crisis, when on a daily basis capital erosion was happening and MF were announcing segregated portfolio. Fully believe in Asset Allocation.

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Thinking out loud - if equity and debt balance each other - isn’t that stability enough? Does the credit/interest rate risk with debt not upset the balance?

Thanks for the interesting views. FDs would be great, but I wish Zerodha allowed pledging them for margin. Let me hypothesise three possible scenarios:

  1. Equity markets do well - Gold depreciates
  2. Equity markets depreciates - Gold appreciates
  3. Equity markets remain flat - Gold appreciates?

Would Debt also appreciate predictably, albeit to a lesser, degree in all the above scenarios for ensuring the robust growth of a portfolio?

Do note that the bond price has an inverse relationship with interest rate

When interest rate in the market increase the bond price will fall and vice a versa

Ok I made a typo in my earlier post, what I meant to say was that both Equity and Gold are volatile assets. Debt provides stability

What I meant from stability is reduction in volatility.
For equity 20% jump or fall in a month is a normal scenario and very much possible. Same with gold (but to a less extent). Not all investor would be able to live with that volatility. Especially if you have a near term goal coming up.

With debt MF changes (both rise and fall) are less steep, so it reduces the overall volatility of your portfolio.

As said even in such scenarios changes are much gradual (10% drop in debt fund NAV is very rare occurrence) and investor gets time to react. Also you can always invest in Gsec / SDL / PSU debt funds to minimize credit risk event and short term funds to minimize interest risk.

Finally each investor has their own appetite for volatility and risk. Those investing in Crypto, even equity will look less volatile and for those used to FD, even debt fund might look risky. To each one its own :slight_smile:

And interest rates have an inverse relationship with equity markets. So in a way debt would also be directly proportional to equity markets and inversely proportional to gold, but with a lower amplitude?

Hi, please find our views below

Equity mutual funds further wealth creation while Gold acts as portfolio diversifier. Let’s understand what relevance Debt Funds play in your portfolio.

Qualify As a Source of Emergency funds

A Liquid fund is one category of Debt Mutual Fund that invest in instruments of short duration not exceeding 91 days. The portfolio of a liquid fund scheme comprises of G-secs, T-Bills, commercial paper, and quality PSU / PFI securities.

Due to the short duration, they also qualify as a source of parking one’s emergency funds. The lower maturity period of these underlying assets helps a fund manager in meeting the regular redemption demand from investors. Investors can withdraw when in urgent need of money due to unexpected loss of employment, medical emergencies, travel, etc. Liquid funds work as emergency funds due to the low interest rate and credit risks that such schemes generally have.

Thus, to park one’s emergency reserves, investors can use liquid funds within debt funds category to complement their portfolio.

It is suggested that investors can park money worth 12 months of monthly expenses’ in Liquid funds. Depending on the risk profile, investors can have up to 36 months of expenses in a liquid fund. Investors who have minimal financial obligations can lower need for emergency reserves equivalent to 6 months of monthly expenses.

As a general guideline, we suggest investors first have this emergency fund in place before investing in equity mutual funds or Gold.

Offer Liquidity

An open-ended Debt funds are liquid since they can be redeemed as per need.

Relatively Less volatile

Debt funds are relatively less volatile compared to Gold and Equity mutual funds and bring stability to an investor’s portfolio.

Indexation Benefit commensurate with inflation

Debt Fund Tax is applicable as per the holding period. For short term capital gains of lesser than three years, the taxation is as per the investor’s income tax slab. For long-term capital gains exceeding three years, liquid funds are taxed as per 20% with indexation benefit. When subjected to indexation, it reduces the long-term capital gains tax, which brings down your taxable income.

What is the correlation of Debt Mutual Fund in an investor’s portfolio?

Asset classes move in cycles. What investors must note that it is difficult to predict the next best performing asset class. Different asset classes perform differently as per different macroeconomic developments and tend to move in cycles. Therefore, which asset will be useful in that kind of scenario, is unpredictable.

There have been years when equity markets had a brilliant run, years when only bonds were dependable, and years when gold shined the brightest, and these periods did not typically overlap. For instance, imagine a scenario where an investor would have redeemed all their investments in equities in the 2008 Global Financial Crisis where equity markets corrected by over 52% and missed out in the rally that followed in 2009. Whereas Gold generally has an inverse relationship with equities and helps lower downside risks and performs better when other asset classes are under stress. As you can see in the illustration below, Debt funds are not as volatile as Gold and Equities.

Past performance may or may not sustained in future *The chart ranks the best to worst performing indexes per calendar year from top to bottom Data as of February 2022 Past performance may or may not be sustained in future. Based on S&P BSE Sensex; Domestic Gold prices and CRISIL Composite Bond Fund Index Source: Bloomberg

And therefore, each asset will play a role in different kinds of scenarios.

Equities over the long term is one of the best asset classes for wealth creation has the potential to outperform the rate of inflation. But at the same time, equity mutual funds are volatile in the short term and investors need to be prepared for portfolio drawdowns due to market risks. They are suitable for long term investment tenure.

Debt funds returns are relatively stable and bring liquidity to your portfolio and lowers impact of market movements.

Gold plays a risk-reducing, portfolio diversifying role and limits downside risk in your portfolio.

So, you mix all three in a proportion that will help you sail any kind of market environment. The imperfect correlation between these asset classes & regular rebalancing of the portfolio will ensure investment balance and minimize the impact of losses driven by falling markets.

Disclaimer: The views expressed here in this Article / Video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The Article / Video has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate, and views given are fair and reasonable as on date. Readers of the Article / Video should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. None of the Quantum Advisors, Quantum AMC, Quantum Trustee or Quantum Mutual Fund, their Affiliates or Representative shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary losses or damages including lost profits arising in any way on account of any action taken basis the data / information / views provided in the Article / video.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Debts have assued returns whereas there is no assured returns for equity. Also there is no gurantee that gold will definitely work as a hedge against Equity. Even if its working as a hedge you are just covering your loss and not making any returns on your investment.