What are the new debt fund categories
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Debt funds are no longer going to come packaged simply as short-term income funds or long-term income funds. These categories were found to be very broad and did not define the specific interest rate risk attached to a fund.
For example, a mutual fund with an average maturity of 4 years could also fall in the short-term income fund category along with a fund which has a 1.5-year average maturity. The new categorisation guidelines from Securities and Exchange Board of India (Sebi) now specify more targeted categories around level of interest rate risk and credit risk taken by the fund. Here are some changes that you need to look out for.
Short term income funds
This broad category will no longer exist; instead there are four types of funds you can look out for. The Low Duration fund category will look at investing in debt and money market securities so that the portfolio duration is between 6 to 12 months.
Duration measures the sensitivity of bond price to changes in interest rates and is measured in years. Higher the time duration, the riskier a bond investment is as bond prices fall with rise in interest rates. A rise in rates has a greater impact on price of longer term bonds with fixed coupons. Next, there is a category called Short Duration fund which will invest and the portfolio duration is from 1-3 years. Lastly, the Medium Duration fund category will have a portfolio duration between 3-4 years. There is an additional category called Money Market Fund which will invest only in money market securities up to a duration of 1 year. Money market securities are short term debt securities used by governments and corporates to raise money typically for a period which is less than a year.
Long term funds
Long term funds are now broken down to Medium to Long Duration funds which can invest in securities such that portfolio duration is 4 to 7 years and Long Duration Funds which can invest such that portfolio duration is 7 years. Here, the interest rate risk is higher given the longer-term duration.
The guidelines allow for the fund managers in Medium to Long Term funds and Medium Duration funds (mentioned earlier) to reduce portfolio duration to a minimum level of up to 1 year in case of anticipated adverse market conditions.
Earlier there were no separate categories for funds investing majority of assets in corporate bonds.
This new category called Corporate Bond fund will invest at least 80% in corporate bonds rated AA+ and higher. This is to ensure that the category is invested in high quality securities.
A separate category is created called Credit Risk Fund which can invest at least 65% of its assets in corporate bonds which are at AA rating or below. These were earlier called credit opportunity funds.
This type of mutual fund inherently has a higher credit risk which means the risk of default from securities in the portfolio is higher than other debt funds.
The aim with this detailed categorisation is to help investors identify the maximum permissible risk level, be it interest rate or credit, clearly at the time of investment.