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Which type of risk is attached with investing in banking & PSU debt funds?

Ashutosh Gupta sheds light on the risk-return profile of banking and PSU debt funds

Which type of risk is attached with investing in banking & PSU debt funds? Are they safe from interest-rate fluctuations?
- Amar Shahane

Banking & PSU funds generally rank low in risk in comparison with many other debt categories. As the name suggests, they invest in bonds of banks and public-sector companies and the underlying portfolio quality is usually high in terms of overall credit quality.

These funds also usually maintain a short to medium duration range for their portfolios of three-five years. So while they are not completely insulated from interest-rate fluctuation, the impact of change in interest rates is much lower than what it is on categories like dynamic bond funds or other medium- to long-duration categories.

A lot of these funds are also managed on a roll-down strategy, wherein a fund manager builds a portfolio with a defined average maturity and then holds on to it and lets the average maturity roll down gradually as time passes by. For instance, a fund manager can build a portfolio with an average maturity of about four years and then let that maturity roll down with time. So, after one year, the average maturity of the portfolio will come down to three years, then two years and so on.

Now in this kind of strategy, if an investor opts to remain invested in the fund during the entire roll-down duration, in our example, if the investor continues to remain invested for the entire duration of four years, then the impact of interest-rate fluctuation on his overall returns will be minimal.

So, from that perspective, I'd say the impact of interest-rate fluctuation is fairly minimal. But he has to take note of the fact that these funds rank relatively low on risk. He also needs to have his return expectations in a fairly moderate range from these funds.