Debt Funds On Zerodha: A Step-By-Step Investment Guide

Debt funds are risky and it is important to understand all the risks involved before investing. Debt funds are not risk-free as most people assume, they are susceptible to both default and credit rating risk. The evaluation of a debt fund must be based on risk metrics. The risks involved with debt funds include default risk, credit risk, interest rate risk, and liquidity risk.

There are different types of debt funds, including liquid funds, overnight funds, ultra-short duration funds, banking and PSU debt funds, credit risk funds, and gilt funds. Each type of debt fund has a different level of risk and potential return. When investing in debt funds, it is important to analyze the fund's portfolio, diversification, exposure to companies, credit rating, and modified duration. It is also crucial to align the investment with financial goals and the fund's risk-reward profile.

Zerodha's bond investing platform allows investors to invest directly in bonds, providing access to high-quality PSU and corporate bonds with the highest credit ratings. The platform provides vital information such as tax implications, credit ratings, and maturity dates.

Before investing in debt funds on Zerodha, it is essential to understand the risks, evaluate the different types of debt funds, and analyze the funds' portfolios to make informed investment decisions.

Understanding the risks associated with debt funds

When investing in debt funds, it is important to understand the associated risks. Debt funds are subject to various risks that can impact the returns on investment. Here are some of the key risks to consider:

• Interest Rate Risk: Interest rate risk is the possibility that changes in interest rates will affect the price of debt funds. When interest rates rise, bond prices tend to fall, and vice versa. This risk is present in all debt funds, but the degree of risk can vary depending on the maturity of the fund. Longer-term debt funds tend to be more sensitive to interest rate changes.
• Credit Risk: Credit risk refers to the possibility of the issuer of a fixed-income instrument defaulting on interest or principal payments. The credit quality of the issuer is assessed by rating agencies, and a downgrade in the credit rating can lead to a decrease in the price of the instrument. Credit risk is considered permanent, as a default can result in a permanent loss for investors.
• Liquidity and Concentration Risk: Liquidity risk refers to the ability to buy or sell an investment without impacting its price. In the context of debt funds, it is important for the fund manager to ensure sufficient liquidity to manage redemptions without affecting the fund's value. Concentration risk, on the other hand, refers to the proportion of holdings in a specific bond. A higher concentration in a particular security increases the risk of loss if that security defaults.
• Cashflow Risk: This is the risk of irregular or skipped payments by the borrower. It can lead to a reduction in expected cash flow for the lender, potentially triggering a chain of negative events.
• Default Risk: Default risk is the possibility that the borrower may become insolvent and decide not to repay the loan. This is often associated with a deterioration in the borrower's credit rating.
• Asset Risk: In the event of a borrower's default, the lender has the right to sell the hypothecated assets. However, there is a risk that the value of these assets may also decline, resulting in a loss of both principal and asset value for the lender.

It is important for investors to carefully consider these risks before investing in debt funds. The risks associated with debt funds can vary depending on the specific fund and the economic environment. By understanding these risks, investors can make more informed decisions and select funds that align with their risk appetite and investment goals.

How to invest in debt funds via Zerodha Coin

Investing in debt funds via Zerodha Coin is a straightforward process. To get started, follow these steps:

Step 1: Sign Up for a Zerodha Account

If you don't already have a Zerodha account, you'll need to sign up for one. You can do this by visiting the Zerodha website and clicking on the "Open Account" button. You will need to provide some basic information, such as your name, email address, and phone number. Once you have provided this information, you will be asked to set up your login credentials, including a password.

Step 2: Complete the KYC Process

Before you can start investing, you will need to complete the Know Your Customer (KYC) process. This is a standard procedure for all investment platforms in India. You will need to provide proof of identity and proof of address, such as a passport, driver's license, or utility bill. Once you have submitted these documents, Zerodha will verify your information, which usually takes a few days.

Step 3: Fund Your Account

Once your account is verified, you will need to fund it before you can start investing. You can do this by linking your bank account to your Zerodha account and transferring funds electronically. Zerodha supports various payment methods, including net banking, UPI, and IMPS. Make sure you have enough funds in your account to cover the minimum investment amount for debt funds, which is typically ₹500 or ₹1000.

Step 4: Log In to Zerodha Coin

Zerodha Coin is Zerodha's mutual fund investment platform. To access it, log in to your Zerodha account and click on the "Coin" tab. This will take you to the Coin dashboard, where you can browse and search for debt funds to invest in.

Step 5: Choose a Debt Fund

On the Coin platform, you will find a wide range of debt funds to choose from. You can use the search bar to look for specific funds or use the filters to narrow down your options based on criteria such as fund type, rating, and performance. When selecting a debt fund, consider factors such as your investment goals, risk tolerance, and the fund's historical performance.

Step 6: Invest in the Debt Fund

Once you have selected a debt fund, you can invest in it by clicking on the "Invest" button. You will be asked to specify the amount you want to invest and the frequency of investment (lump sum or SIP). Review the details of your investment, including the fund name, amount, and frequency. If everything looks correct, confirm your investment.

Step 7: Monitor Your Investments

After investing in a debt fund, it's important to monitor its performance regularly. You can do this by logging into your Zerodha Coin account and checking the dashboard, which provides an overview of your investments. Click on the individual debt funds in your portfolio to view more detailed information, such as historical returns and fund ratings. You can also set up alerts and notifications to stay updated on the performance of your investments.

By following these steps, you can easily invest in debt funds via Zerodha Coin. Remember to do your research and understand the risks associated with debt funds before investing. Happy investing!

The difference between liquid funds and overnight funds

Liquid funds and overnight funds are both types of debt mutual funds. They are similar in that they offer high liquidity and low risk. However, there are some key differences between the two.

Liquid funds invest in short-term debt instruments, typically with maturities ranging from a few days to a few months, with a maximum maturity of 91 days. They aim to provide investors with easy access to their funds while generating reasonable returns. Liquid funds can be used to park surplus funds for a short period, usually in excess of seven days. They carry slightly more volatility and higher return potential compared to overnight funds.

On the other hand, overnight funds focus on extremely short-term instruments that mature within one business day. They are considered the lowest-risk category within debt mutual funds as they have near-zero credit risk and zero interest rate risk. Overnight funds are meant for very short-term money, typically for investors with a time frame of one day to a week. They do not carry any exit load, while liquid funds have an exit load for up to seven days.

In summary, liquid funds offer slightly higher returns due to their broader investment horizon, while overnight funds focus on extremely short-term and secure instruments, making them the least risky option among debt mutual funds.

How to analyse a debt mutual fund

Before investing in a debt mutual fund, it is important to understand the associated risks. Debt mutual funds carry credit risk, interest risk, and change in credit rating risk. Credit risk refers to the possibility of the borrower defaulting on interest or principal payments. Interest rate risk is the sensitivity of bond prices to changes in interest rates, with higher modified duration indicating greater risk. Change in credit rating risk occurs when a company's credit rating is downgraded, leading to a decrease in the price of the debt instrument.

When analysing a debt mutual fund, it is crucial to assess the fund's portfolio. Examine the diversification of the fund, exposure to individual companies, and the credit rating of the instruments held. A high exposure to corporate bonds indicates higher credit risk. Sovereign bonds, on the other hand, carry no credit risk but are subject to interest rate risk. It is recommended to avoid funds with overly concentrated portfolios or large exposures to a single entity.

The average maturity of the fund is another important factor. The minimum investment duration in a debt fund should be equal to or greater than its average maturity. For example, if a fund has an average maturity of 2.5 years, investors should be prepared to stay invested for at least that long.

Other key factors to consider when analysing a debt mutual fund include:

• Modified duration: This indicates the sensitivity of the fund to interest rate changes. A lower modified duration suggests lower interest rate risk.
• Yield to Maturity (YTM): YTM represents the expected returns from the fund if the instruments are held until maturity. A higher YTM indicates higher potential returns but also higher risk.
• Credit rating: Match your risk profile with the fund's credit rating. Liquid funds, for instance, typically invest in high-rated treasury bills.
• Current interest rate scenario: Monitor interest rate movements as they can impact the performance of different types of debt funds.
• Number of securities: Avoid funds with overly concentrated or overly diversified portfolios.
• Assets Under Management (AUM): Larger AUMs may provide better negotiating power for interest rates and help avoid redemption pressure. However, very large funds may face debt market liquidity issues.
• Reinvestment risk: This occurs when a fall in interest rates coincides with the maturity of the fund's instruments, leading to reinvestment at lower rates.
• Market risk: Debt funds are linked to the stock market and can experience fluctuations.
• Concentration risk: Avoid funds with high exposure to a single entity, as a default by that entity can significantly impact the fund's performance.

In summary, when analysing a debt mutual fund, focus on understanding the risks, evaluating the portfolio quality and diversification, considering the average maturity, and assessing other key factors such as YTM, credit rating, AUM, and market risks. Remember that investment in debt funds should align with your financial goals and risk tolerance.

The pros and cons of investing in Gilt funds

Gilt funds are a type of mutual fund that invests in government bonds. They are part of the larger category of debt funds. Gilt funds are considered low-risk investments that offer moderate returns. However, there are some pros and cons to investing in gilt funds that you should be aware of.

Pros of Investing in Gilt Funds:

• Exposure to government securities: Gilt funds provide an opportunity for retail investors to gain exposure to government-issued bonds, which are typically not accessible to individual investors.
• Minimal credit risk: Gilt funds are considered to have minimal to no credit risk because the underlying securities are issued by the government, which is assumed to have a low probability of defaulting on its obligations.
• Moderate returns: Gilt funds are known to provide moderate returns with minimal to no risk. They are suitable for individuals with short to medium-term investment horizons.
• Ideal for risk-averse investors: When compared to equity funds, gilt funds offer better asset quality despite their relatively lower returns. They are often considered ideal for investors who are risk-averse and want to invest in government securities.

Cons of Investing in Gilt Funds:

• Interest rate risk: Gilt funds are primarily exposed to interest rate risk. When interest rates rise, the net asset value (NAV) of the fund can drop sharply, leading to potential losses for investors.
• Limited upside: Gilt funds have a capped upside potential due to the relatively stable nature of government securities.
• Liquidity risk: While gilt funds are considered more liquid than other types of debt funds, investing in long-term government securities through gilt funds may still carry some liquidity risk. It can be difficult to switch out of these investments quickly.
• Management fees: Gilt funds charge an annual management fee, known as an expense ratio, which is limited to 2.25% of the NAV by SEBI. This adds to the overall cost of investing in gilt funds.
• Longer investment horizon: Gilt funds typically invest in government securities with medium to long-term maturities, ranging from three to five years or more. Therefore, investors need to have a similar investment horizon to avoid potential losses from selling early.

In summary, gilt funds offer a unique opportunity for investors to gain exposure to government securities with minimal credit risk. However, they are sensitive to interest rate changes and may not provide high returns compared to other riskier investments. Investors should carefully consider their investment goals, risk tolerance, and time horizon before deciding to invest in gilt funds.

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