PSU Debt Fund – A Safe Haven for Conservative Investors

What are PSU Debt Funds?

According to the Securities and Exchange Board of India (SEBI) classification, open-ended funds that invest 80% or more of their corpus in debentures, bonds, banking, and public sector undertakings (PSUs) are termed as Banking & PSU Debt Fund. In 2017, SEBI, the statutory body that regulates India’s mutual fund market, announced that municipal bodies’ debt securities offerings can also be clubbed under the portfolio of a banking and PSU fund. In general, banking and PSU debt funds carry relatively less risk and have good credit ratings. Let’s explore these in more detail.

Table of Contents hide

1 What are PSU Debt Funds?

2 Features of Banking and PSU Debt Fund

3 Benefits of investing in PSU debt funds?

4 What are the risks and limitations with Banking and PSU Debt Funds?

5 How to choose the right PSU Debt Fund

6 Who should invest in Banking and PSU Fund?

7 Taxation of PSU Debt Funds

8 Top performing banking and PSU fund in 2023

9 Conclusion

10 Frequently Asked Questions

11 Related Links

Features of Banking and PSU Debt Fund

Banking and PSU debt funds are some of the most sought-after mutual funds, especially by investors who have a low-risk appetite. While selecting investments of these open-ended debt funds, fund managers mostly include Maharatna and Navratna companies since the risk factor is substantially low.

Some of the key features of banking and public sector undertaking fund are:

80% of the banking and PSU debt funds are debentures, government bonds, certificates of deposit, and others.
Asset Management Companies (AMCs) that offer these mutual fund schemes have at least “AAA-” credit ratings.
These open-ended funds have low risk associated with them as the fund portfolio is procured from debt securities.

Benefits of investing in PSU debt funds?

Investors can look forward to availing below-mentioned benefits by investing in Banking and PSU Debt Funds:

Liquidity

Since the investment focus of these funds is in top-rated instruments (such as bonds of NABARD, SIDBI, etc.), they are highly liquid funds. Investors can gain stable returns as PSU bonds are frequently traded and fund managers can make the most of capital appreciation opportunities during price drops. This can benefit investors who are looking for returns within a short time period of 1-2 years.

Low Risks

Banking and PSU Funds have a relatively low risk of market volatility since they invest in quality funds that have a high credit rating and focus on short/medium-term investments. While it may not be entirely risk-free but comes with lower risk when compared to debt funds like Dynamic Bond Funds or Credit Risk Funds.

Better Returns

Banking & PSU funds can be easily replaced by Fixed Deposits in any investment portfolio, especially if one is looking to earn slightly higher returns within a short tenure and with limited risks. These can be safe havens during a debt crisis since they can offer better price discovery to investors.

What are the risks and limitations with Banking and PSU Debt Funds?

The risks in banking and PSU debt funds are comparatively low, as the corpus comprises PSUs and banks’ debt instruments. These institutions are backed by the central government, and the fund schemes are substantially secured compared to equity funds.

However, just like any investment, there is always a tradeoff between the returns earned and the risk associated. Here are a few limitations of these funds that the investor should keep in mind prior to investing in these funds:

High Net Asset Value (NAV): Due to the low-risk factor of PSU debt funds, they see a huge demand in the market. Investors often pick these securities to balance out the total risk of their portfolio. This results in a higher cost of investment in the funds which could result in a financial burden on the investor as well.
Low returns: In general, the returns on debt instruments are lower when compared to equity investments. The portfolio of a PSU and banking debt fund is primarily made up of large-cap companies, and there is very little chance of diversification in the composition of these funds. As a result, the prices remain stagnant and so do profits.
Short investment tenure: Banking and PSU funds are ideal investments for a short holding, i.e., 1 to 3 years.

How to choose the right PSU Debt Fund

When choosing the right PSU (Public Sector Undertaking) debt fund, consider the following factors:

Fund Objective: Understand the fund’s objective, which may include generating income, preserving capital, or a combination of both. Choose a fund that aligns with your investment goals.
Credit Quality: Evaluate the credit quality of the PSU debt instruments held by the fund. Look for funds that primarily invest in highly rated PSU bonds to ensure stability and minimize credit risk.
Fund Performance: Analyze the historical performance of the fund over different time periods. Consider consistent returns and compare them with appropriate benchmarks and peer funds.
Fund Manager Expertise: Assess the experience and track record of the fund manager. Look for a manager with expertise in managing debt funds and a good understanding of the PSU bond market.
Expense Ratio: Consider the expense ratio of the fund, as lower expenses can have a positive impact on your returns over the long term.
Fund Size and Liquidity: Evaluate the fund’s size and liquidity. A larger fund size and higher liquidity can indicate better ability to handle redemption pressures and provide smoother transactions.
Risk Factors: Understand the risks associated with PSU debt funds, such as interest rate risk and credit risk. Assess your risk tolerance and choose a fund accordingly.
Fund House Reputation: Consider the reputation and credibility of the mutual fund house managing the PSU debt fund. Look for a fund house with a strong track record and prudent risk management practices.
Scheme Details: Read the scheme documents carefully to understand the investment strategy, asset allocation, and any specific investment restrictions of the fund.

Who should invest in Banking and PSU Fund?

Banking and PSU debt funds are the best suited for risk-averse investors. Instruments included in these funds have government backing and are therefore less risky than any equity funds.

Since these are debt funds, they are not easily affected by market volatility and are therefore suitable for investors who have a low-risk appetite.
Investors who are looking for an alternative to bank deposits like FDs can consider investing in these funds.
Investors who wish to invest in debentures carrying a high credit quality and offer greater liquidity.
Investors who have an investment horizon of 1-3 years can invest in these funds, since the average maturity period of these funds is 1-2 years.

These funds can be used by investors who invest heavily in equity funds and want to mitigate the risk factor of their portfolio. In adverse situations, like the one the market has seen during the pandemic, investment in banking and PSU debt instruments can act as a cushion.

Taxation of PSU Debt Funds

As per the Finance Bill 2023 amendment, capital gains arising from debt mutual funds will be classified as only short-term capital gains. This means that gains arising from PSU debt mutual funds will be added to your taxable income and taxed at your income tax slab rate.

Short-term capital gains tax is applicable if debt fund units are sold before 3 years from the date of purchase. In this case, proceeds are taxed as per the investors’ slab rate. Thus, it will be 31.20% (30% + 4% cess) for investors in the highest tax bracket.

Top performing banking and PSU fund in 2023

Here are the details of the top PSU funds:

IDFC Banking & PSU Debt Fund
Axis Banking & PSU Debt Fund
ICICI Prudential Banking and PSU Debt Fund
Kotak Banking & PSU Debt

IDFC Banking & PSU Debt Fund

About Fund

The objective of the scheme is to achieve optimal returns through investment focus in money market and debt instruments that are primarily issued by scheduled commercial banks. It is ideal for investors who have a low risk appetite and prefer to invest in debt funds over bank deposits.

Inception Date	March 07, 2013
Benchmark Name	NIFTY Banking and PSU Debt Total Return Index
Fund Manager	Suyash Choudhary
Expense ratio	0.31%
Fund type	Open-ended
Risk	Low