flexibility to diversify into various debt instruments. At the time of redemption, large funds do not need to worry about exiting investments from key government bonds having high mandatory entry ticket size, but a small fund may crash due to redemption pressure. Investors should focus on debt funds with large AUM.
It is important to analyse the past performance of debt funds with respect to various interest rates over different periods. Such an analysis would show the performance capacity of the debt fund under different scenarios; based on that, an investor can decide on the amount and duration of investment. Normally, every debt fund shows good returns when the interest rates are going down. The real test comes when the rates are rising.
Though most direct debt instruments are not traded on the exchanges, debt funds are. One crucial choice to make is between the regular dividend payout method or the growth option. Dividends disbursed under the dividend payout option are not taxable in the hands of the investor, but the fund is directly liable to tax; therefore, it is indirectly adjusted from the net asset value (NAV).
Under the growth option, the investor is directly liable to capital gains tax, i.e., 10% of the gain without indexation or 20% with indexation, whichever is less. If investors (especially those falling under 20% and 30% tax brackets) are not specifically looking for regular income, it is advisable to go for a growth option. In other words, you must analyse post-tax returns under both options before making a choice.
The writer is CEO, BankBazaar.com