Know what passive debt funds are and how to choose them
Passive debt funds are mutual funds that invest in a fixed-income portfolio to match the performance of a particular benchmark index. These funds are designed to give investors a low-cost and diversified way to gain exposure to the fixed-income market.
How do passive debt funds work?
Passive debt funds are mutual funds that invest in a portfolio of debt securities in proportion to the representation in a market index. In India, passive debt funds track indices such as Nifty Gilt Index, Nifty AAA Bond Index, and Nifty Corporate Bond Index.
Passive debt funds work by replicating the index they track through a debt securities portfolio. The fund manager aims to match the underlying index’s returns by investing in the same securities and the same proportion as the index. Since passive debt funds do not involve active management, the expense ratio for these funds is generally lower than actively managed debt funds.
Investors can buy and sell passive debt funds on the stock exchange throughout the trading day, similar to equity shares. These funds offer liquidity and transparency to investors, as the NAV of the fund is updated regularly and reflects the underlying value of the portfolio.
Here are a few factors to consider when evaluating passive debt funds:
Expense ratio
Passive debt funds typically have lower expense ratios than actively managed funds. However, it is still important to compare the expense ratios of different passive debt funds to find the one that charges the lowest fee. A lower expense ratio means more of your money is invested in the fund, potentially leading to higher returns.
Fund management fees
One of the main benefits of passive debt funds is their low management fees. However, prices vary between funds; even small cost differences can impact your investment returns over time. Look for a fund with a low expense ratio, the percentage of assets the fund charges to cover operating expenses.
Liquidity of the fund
Liquidity refers to the ease with which you can buy or sell units of the fund. Choosing a fund with high liquidity is essential, especially if you plan to make frequent transactions. Funds with higher assets under management (AUM) typically have higher liquidity as more investors buy and sell.
Tax implications
The tax implications of investing in passive debt funds depend on the investor’s tax bracket and the holding period of the investment. Generally, assets over three years are considered long-term and attract a lower tax rate than short-term investments.
Diversification
Passive debt funds offer investors a low-cost way to achieve diversification across multiple bonds and sectors. Look for a fund that invests in various adhesives across different sectors, such as government, corporate, and mortgage-backed securities. This can help reduce the risk of a single bond or sector adversely affecting your investment returns.
Conclusion
Passive debt funds offer investors a low-cost, low-maintenance way to invest in the fixed-income market. By considering these factors, investors can make informed investment decisions and select the passive debt fund that aligns with their investment objectives and risk tolerance.