What is the ideal horizon to invest in debt mutual funds and FMPs?

Subir Jha, Founder, BuckSpeak, a Hyderabad-based wealth management firm.

Questions asked by his clients:
1. FMPs are giving little more than the principal amount and are facing issues due to defaults. What to do?
2. Will debt mutual fund investors not get the money back if there is a default or downgrade?

3. What should be the ideal time horizon if one wants to invest in debt funds and FMPs?

His response to the investors:
A year ago, investors used to believe that debt mutual funds will give great returns with no risk involved. This myth is no more there, as investors have started witnessing defaults and downgrades in the debt mutual fund space during the last year.

To begin with, investors need to understand that they can’t expect higher returns from products that offer higher safety.

Many such investors land up in FMPs. FMPs have small portfolios and hence they are not diversified like the other open-ended schemes. Because of this small portfolio, the concentration risk in these schemes is very high. Anything happens to one of the 7-8 papers and the scheme is hit badly. Investors must understand that FMPs do not have a liquidity option. If you are invested in a bad portfolio, you are stuck. With no choice and less liquidity, FMPs are not the most ideal kind of debt products. If you don’t understand it, stay away from it.

If your FMP has defaulted. You don’t have the choice but to stay invested. You have to follow up with your AMC about when your money will come back. In many cases, the AMC promises to give the money back to the investors when there is a resolution.

Secondly, FMPs are different from other debt mutual fund schemes. Sure, many open-ended schemes also got hit by a series of downgrades and defaults, but the impact was not that much. So, there are different kinds of debt schemes that may or may not take extra risk for extra returns.

If you are fully aware of the fact that you are taking extra risk for extra returns, make sure you have extra time also. Over years we have just spoken about the importance of time frame in equity schemes but this is high time we speak about time frames in debt schemes. If you don’t have more than three years, don’t choose a credit risk fund. The schemes that take higher risk, like small cap funds, need extra time. This is to safeguard your money from sudden disruptions.

If your goal is less than three years away, stay in safer schemes like liquid funds, short duration funds, and so on. Also, don’t forget the tax implication. If you can stay invested for minimum three years, do that to save on the extra taxation.