Are bond baskets better than debt funds?

Are fintech-held bond baskets a viable alternative to debt mutual funds, and do they offer any tax benefits?

— Name withheld on request

In the case of a debt investment, your fund manager, or the fintech you are investing through, lends the money to various companies. These investments earn interest. Interest and principal are payable according to a pre-defined timeline. Therefore, the quality of the institution to which the money is lent plays a vital role.

The credit risk is high when there is a high possibility that the borrower will fail to pay interest or repay the principal on the predetermined day. The better the company in terms of fundamentals and quality, the less likely there will be problems with those investments. Established companies, or companies with a solid track record, usually offer lower rates compared to companies in the growth stage. Non-payment of interest or principal directly affects investors so this credit risk is an important factor to consider at the time of investment.

The interest rate and bond price have an inverse relationship, when the interest rate increases the bond price decreases and vice versa. The interest rate in India keeps fluctuating based on many factors like demand and supply of money, inflation, government loans, etc. Interest rate risk is the impact on the entire portfolio due to a change in the interest rate. For example, you hold long-term maturity debt instruments at an interest rate of 7% per annum and if the interest rate rises to 8%, the value of your instrument will decrease as the investment needs to generate matching interest . with the revised interest rate of 8%. The longer the duration of the bond, the higher the interest rate risk.

Many companies or startups offer higher rates and raise investment through the fintech platforms. These fintech platforms also do their due diligence before listing these companies on their platform. When it comes to debt funds, the first thing any fund manager will look for is to reduce the risk because the main reason investors invest in a debt instrument is to take less risk. Based on different types of objectives, the funds will invest in different companies and institutions to diversify the investment.

The baskets of bonds offered by fintechs may generate higher returns but may involve additional risk. A debt fund is more diversified and invests in established institutions. Debt funds also look at the interest rate cycle since it affects the price of the underlying asset which is the bond, which may not necessarily be the objective of the basket offered by fintechs.

Harshad Chetanwala is the co-founder of MyWealthGrowth.

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Updated: 06 November 2023, 10:27 PM IST

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