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Investing in Debt Funds

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Investing in Debt Funds

Debt securities (bonds) are a fundamental part of an investing plan for most investors. There are many types of bonds along with varied approaches to debt fund investing, each with their own advantages and levels of risk. Although stocks have historically outperformed bonds over the long term, there are a number of reasons to include a debt fund in a diversified portfolio, including:

Income

• Debt Funds generally offers higher yields than equities or other securities as well as regular coupon payments, providing bond owners a potentially attractive, regular income stream.

Capital Preservation

• Some investors may not want to take a significant amount of risk with their portfolios. Bond prices, especially those of high-quality bonds, tend to be less volatile than other securities, typically offering investors a lower risk profile.

Diversification

• Debt securities have historically demonstrated a low correlation to equities, meaning there is little relationship between how the two asset classes have performed over a given time. Therefore, owning debt funds along with equities adds a potential risk-reducing effect to an investor's portfolio.

What are the risks involved in debt investing?

Investing in debt funds entails specific kinds of risks. Interest rate risk affects all debt funds investing, and credit and cash flow risk relate more to specific individual investments.

Interest Rate Risk

• A broad risk associated with buying and holding fixed income investments is interest rate risk—the possibility that the relative value of a bond will decline due to an interest rate increase. In general, as rates rise, the price of a bond will fall, and vice versa.

Credit Risk

• This includes default risk, which is the risk that a bond issuer, usually due to financial hardship, will be unable to fully repay the loan represented by the bond. If an issuer is expected to have difficulty in meeting its payment obligations, its credit rating could be lowered, negatively affecting its value. This is known as credit quality risk. Individual bonds are also prone to event risk—the possibility that a business, economic or political event will negatively impact the value of the investment. Event risk is largely a concern in corporate bonds, which are bonds issued by companies. Government bonds are debt obligations of the government that are backed by the "full faith and credit" of the government and, therefore, are not subject to credit risk.

Cash Flow Risk

• Though bonds have a stated maturity, some can be called away by an issuer ahead of its maturity date. Some fixed income securities, such as mortgage-backed securities, have embedded call options which may be exercised by the mortgage holder. The risk associated with the early return of principal on a fixed income security is called prepayment risk. In contrast, extension risk is the possibility of a security lengthening in duration due to the deceleration of prepayments. Both can diminish a bond's total return and alter its risk/return characteristics.

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How Are Equity Funds Managed contd.

To help minimize cash flow risk, direct bondholders generally buy high-quality securities without embedded call options. While this does offset some risk, holding high-quality securities can cause investors to forfeit potentially higher investment returns.

How to invest in debt assets?

There are a number of ways for investors to gain access to debt assets, including by purchasing individual bonds or investing in actively managed debt mutual funds. Because investors have diverse investment goals, there is no "one size fits all" approach to owning bonds. However, active portfolio management, led by an investment team and driven by professional analysis, can provide a solid foundation to the fixed income portion of many investors' portfolios.

The Benefits of investing in debt funds

With active portfolio management, a portfolio manager and team of research analysts select securities in an attempt to offer shareholders index beating returns along with prudent levels of risk. There are several strategies unique to active portfolio managers and unavailable to more passive forms of investing. The three general areas where active management delivers value are: greater access to markets, fundamental analysis and advantages in the execution of trades on behalf of investors.

Access

• Because they pool assets of many investors, managed portfolios buy both a larger number and wider variety of debt securities than available to most individual bond buyers. This provides greater diversification—a strategy of owning dissimilar securities to help lower overall portfolio risk.

Analysis

Active portfolio management channels the collective insight and analysis of a team of investment professionals and equips the portfolio manager with flexibility to make adjustments to the funds portfolio.

Portfolio managers have the expertise to pick and choose among the range of debt securities that they believe have the best potential, and can dedicate the time and resources needed to monitor portfolio holdings to determine if better opportunities exist elsewhere.

Central functions of active debt management include performing credit research, undertaking detailed analysis, forecasting creditworthiness of individual debt securities and following larger trends in the debt market. These can help minimize risk and exploit market opportunities.

In addition, active investment managers conduct sector and sub-sector analysis to determine which parts of the debt markets appear attractive enough to emphasize in the portfolio. To combat interest rate risk, portfolio managers may adjust the duration of a portfolio if their research supports it.

Execution

Investment institutions that run managed bond portfolios have relationships with large bond dealers and regional specialists that typically enable them to buy bonds at lower prices than those available to retail clients. The advantages of speed and size when making trades help investment institutions keep costs in check, delivering value to the investor.

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Types of Debt Funds

Today, there are many options of Fixed Income Fund available to Indian investors –

Liquid Funds: These have lowest risk as the term of the securities that the fund invests in can not be more than 91 days. These types of funds are mainly used for cash management. As the risk is low, the term of your investment can be of even one day. The investors who maintain a high amount in their savings account or current account, Liquid Funds can be a good option for them.

Short Term Funds: The term of the securities that the fund invests in is mainly of three to five years. Because of this, the level of risk in these funds is more than liquid funds. These are mainly useful for those investors who wish to invest their capital for a period of 6 months to 2 years.

Bond Funds: Investment in these funds should be made at the time when interest rates are likely to decline as the term of the securities that the fund invests in is typically for the long term. As a result of this the risk factor is more than the pre-recognised funds.

Gilt Funds: These funds invest basically in the securities issued by the government of India. The risk factor in these is mainly similar to the Bonds funds. But the risk is only related to interest rate movement. As the investment is made only in the government securities, it doesn’t have a credit risk at all.

Fixed Maturity Plans: This is also called as FMP. In these kinds of funds it is necessary that there is propriety between your term of investment and the term of Mutual Fund, as there is limited scope for withdrawal of your capital before the due date as compared to the other funds. FMPs are listed on stock exchange(s) and one can sell units through the stock exchange if a buyer is available.

Monthly Income Plans (MIPs): MIP funds are mainly chosen as an option by the investors who are looking for only a marginal exposure to equities. The endeavour of these funds is to give monthly income. But the monthly income depends upon the fact that the fund has a performance benefit with it.

If you had invested in any product of a bank or post office, it is necessary for you to have knowledge of debt funds and the possibilities of investment by them. For this you may need time and advice. You can spare time to invest in such types of funds keeping in mind your needs. Especially, when the rates of interest are escalating today, you can earn more in the post tax return FMP.

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How Are Equity Funds Managed contd.

What are the risks involved in investing in debt funds?

There are no guarantees when investing in a debt mutual fund. Debt funds continually buy and sell their securities to the public at the fund's daily determined net asset value (NAV).

A debt fund's NAV will fluctuate based on the value of its holdings and current market conditions, especially the current level of interest rates. There is no maturity date that a bond fund can provide as a deadline for returning the full amount of your investment.

In addition, it is not possible to determine an expected yield to maturity for a bond fund as you can with individual bonds. With a bond fund, you receive whatever the bond securities are worth at the time you redeem your investments from the fund. It is therefore possible to sustain a capital loss from investing in a bond fund.

Even if the individual bonds in the fund are guaranteed by the government or insured through a private insurer, the value of a bond mutual fund investment can still rise or fall.

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Statutory Details: DSP BlackRock Mutual Fund was set up as a Trust and the settlors/sponsors are DSP ADIKO Holdings Pvt. Ltd. &

DSP HMK Holdings Pvt. Ltd. (collectively) and BlackRock Inc. (Combined liability restricted to Rs. 1 lakh).Trustee: DSP BlackRock

Trustee Company Pvt. Ltd.Investment Manager: DSP BlackRock Investment Managers Pvt. Ltd. Risk Factors: Mutual funds, like securities investments, are subject to market and other risks and there can be no assurance that the Scheme’s objectives will be achieved. As with any investment in securities, the NAV of Units issued under the Schemes can go up or down depending on the factors and forces affecting capital markets. Past performance of the sponsor/AMC/mutual fund does not indicate the future

performance of the Schemes. Investors in the Schemes are not being offered a guaranteed or assured rate of return. Investors in the Schemes are not being offered a guaranteed or assured rate of return. The Schemes are required to have (i) minimum 20 investors and (ii) no single investor holding>25% of the corpus of the Schemes. In case of non-fulfillment of the condition of minimum 20 investors, the investor’s money would be refunded, in full, immediately after the close of the New Fund Offer Period. In case of non-fulfillment with the condition of 25% holding by a single investor on the date of allotment, the application to the extent of exposure in excess of the 25% limit would be rejected, and the allotment would be effective only to the extent of 25% limit would be refunded/redeemed.The names of the Schemes do not in any manner indicate the quality of the Schemes, their future prospects or returns. For Schemes specific risk factors, please refer the relevant Scheme Information Document (SID). For more

details, please refer the Key Information Memorandum cum Application Forms, which are available on the website, www.dspblackrock.com, and at the ISCs/Distributors. Please read the Scheme Information Document and Statement of Additional Information carefully before investing.

References

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