Choice of Debt Index Funds in India 2024: Complete Guide to Low-Cost Options
Sharing a comprehensive list of Debt Index Funds available in India for 2023, alongside target maturity funds (or passive debt funds), detailing their Assets Under Management (AUM) and expense ratios. While index investing or passive equity investing is gaining popularity in India, there is now a noticeable shift towards passive or index-based debt funds.
For many of us who are equity investors, understanding equity products comes easily. However, when it comes to debt mutual funds, there is often apprehension, as these various categories can be challenging for the common man to grasp. Following the Franklin Mutual Fund crisis, many investors became wary of parking their money in debt funds. For such investors, the solution lies in low-cost Debt Index Funds and Target Maturity Debt Funds.
Currently, in India, there are two types of passive debt index funds available.
Open-ended index funds.
The majority of these funds are ETFs. However, recently, Edelweiss Mutual Fund launched a unique open-ended passive index fund, which I discussed in my article “Edelweiss CRISIL IBX 50:50 Gilt Plus SDL Short Duration Index Fund – Time to move to Passive Debt Funds?”. Apart from this option from Edelweiss, most other options available are ETFs. Therefore, for those seeking open-ended debt funds, choices are currently limited (excluding the Edelweiss Mutual Fund mentioned above).
Target Maturity Funds
These open-ended passive debt funds track an underlying bond index with a specific maturity date. The funds hold the bonds in the portfolio until maturity, reinvesting all interest payments received during the holding period. Upon maturity of the bonds in the portfolio, the proceeds are distributed among investors according to their holdings in the fund.
These funds are mandated to invest in government securities, PSU bonds, and SDLs (State Development Loans), thereby carrying lower default risk compared to other types of debt funds. Being open-ended, investors have the flexibility to withdraw their investments if needed or in response to adverse developments concerning bond issuers, such as the possibility of default or credit downgrade (though such risks are minimal for TMFs investing in Gilt Bonds, PSU Bonds, and SDLs).
While TMFs offer liquidity, it’s advisable to hold them until maturity to fully benefit from their structure. For instance, if a TMF matures in 2032, it’s prudent not to anticipate needing the funds before that time.
The Net Asset Value (NAV) of these funds fluctuates daily based on demand and supply in the bond market, a phenomenon known as interest rate risk. Typically, if interest rates rise (e.g., due to inflation), bond prices tend to fall. Therefore, the price movement of bonds is inversely correlated with interest rate movements. This volatility is more pronounced in long-term maturity bonds compared to short-term ones.
If the fund holds 10-year maturing government bonds, volatility tends to be higher in the earlier years and decreases as the bonds approach maturity.
A common misconception revolves around return expectations from these funds. Despite showcasing the YTM (Yield To Maturity), many investors mistakenly believe it guarantees a fixed return on investment, which is not the case.
The YTM (Yield To Maturity) represents the expected return if you invest in a fund and hold it until maturity. If you sell before maturity, your actual returns may differ from the YTM initially shown at the time of investment. This variance occurs because returns are influenced by daily fluctuations in interest rates and bond prices.
If someone chooses to invest on a monthly basis in these funds, the return on investment will not mirror the initial YTM (Yield To Maturity). This is because the price of the underlying bonds fluctuates daily, leading to varying YTMs for each month’s investment, even if held till maturity. Thus, the cumulative return from monthly investments will be influenced by these fluctuating bond prices and interest rate movements over time.
Therefore, it’s crucial not to rely solely on the current YTM when making decisions to sell before maturity or when investing on a monthly basis.
Advantages of Target Maturity Funds
These funds are straightforward to comprehend because they primarily consist of government securities, PSU bonds, and SDLs (State Development Loans), with a limited number of bonds in their portfolios. This simplicity contrasts with the complexity of other types of debt funds available in the market.
Low Cost – These funds offer cost efficiencies compared to actively managed debt funds, with most having expense ratios below 0.2%. This affordability upfront translates into significant savings for investors.
Volatility decreases significantly when comparing typical Gilt Constant Maturity Funds with target maturity funds. Gilt Constant Maturity Funds maintain consistent volatility since their portfolios primarily consist of 10-year maturity gilt, mandated by fund managers. In contrast, target maturity funds experience decreasing interest rate risk volatility as they approach their target maturity dates. This feature naturally reduces the need to shift to lower volatility funds as you approach your financial goals, offering inherent volatility reduction by default.
Credit Risk: These funds are relatively safer compared to other debt funds that also include corporate bonds, as they exclusively invest in government securities, PSU bonds, and SDLs (State Development Loans). However, it’s important to note that they still carry interest rate risk and volatility, which increases with longer maturity periods.
Liquidity: With the exception of ETFs, all other funds in this category are liquid in nature. This ensures that investors do not need to worry about liquidity issues when investing in these funds.
Tax Advantage: These funds are treated like debt funds for taxation purposes. For investors in the highest tax bracket holding them for more than 3 years, they offer greater tax efficiency compared to instruments like Bank FDs or RDs. However, it’s important to note that these funds do not receive any special tax treatment and are taxed according to standard debt fund taxation rules.
Disadvantages of Target Maturity Funds
Return Expectation: There’s a common misconception about the Yield To Maturity (YTM) of these funds remaining constant throughout their maturity period. In reality, the YTM fluctuates daily along with the bond prices. Therefore, if you’re making a lump sum investment, the YTM displayed on that specific day serves as an indicative return, assuming you hold until maturity. However, for monthly investments, each SIP will have a different YTM, influenced by the interest rate movements during your investment tenure. Thus, your actual returns may vary accordingly.
Volatility: Unlike traditional Bank FDs which offer stability, Target Maturity Funds (TMFs) exhibit daily price volatility, especially pronounced in long-term maturity funds. It’s essential to understand and accept this inherent volatility when considering TMFs, rather than viewing them as direct substitutes for Bank FDs.
Tax Burden: Consider a scenario where your investment goal spans 10 years, and you opt for a TMF with a maturity of less than 10 years. In such cases, you’ll face taxation twice: first upon maturity of the TMF and again upon reinvesting the proceeds after 10 years. This results in an unnecessary tax burden that should be carefully considered.
List of Debt Index Funds in India 2023
Where the current AUM and expense ratio fields are blank, it indicates that these are newly launched funds for which data is not currently available. In cases where the expense ratio is listed as zero, it implies that the expense ratio is negligible, akin to being very low.
Conclusion: These products offer simplicity, low costs, and ease of understanding. Investing in them eliminates the risk of default or downgrade, providing peace of mind. However, it’s crucial to be mindful of interest rate risk when selecting these funds. Investing in government or PSU bonds doesn’t exempt them from interest rate volatility, so prudent fund selection is key.
Which debt fund to invest in 2023?
Which Index Fund is best for 2023?
Which Nifty 50 Index Fund is best in 2023?
Where to invest in 2023 India?
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