Debt mutual funds are those mutual funds which invest the majority of their corpus into debt and instruments representing debt such as bonds and debentures. Banking and PSU Funds are a sub-category of debt mutual funds, they are legally mandated to invest atleast 80% of their corpus into debt instruments issued by banking companies, public financial institutions (PFI), and Public Sector Units (PSUs). Banking and PSU Mutual Funds invest essentially in fixed income securities issud by banks and PSUs.Since they are investing 80% of their corpus into highly reliable companies many investors consider them as best debt mutual funds.


Credit risk is one of the most crucial factors in fixed income investments. Because interest rates fluctuate in cycles, interest rate risk can cause NAV changes in debt mutual funds, however, this risk is typically transient in nature. Historically over lengthy investment horizons, interest rate risk is reduced since losses incurred during rising interest rate periods can be made up for during subsequent time periods when interest rate falls. On the other side, credit risk can result in a permanent loss of your money. You run the risk of losing your investment if a bond fails to make interest or principal payments. Therefore, while investing in debt mutual funds, you should always take the credit risk of a debt fund into account.

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Which Debt Securities Have A Lower Chance Of Default?


Government Securities, or G-Secs, and State Development Loans, or SDLs, are two types of sovereign debt securities that have low credit risk because they are backed by the government (i.e. interest and principal payments are guaranteed by the Government). Because G-Secs is required as collateral for Collaterized Borrowing and Lending Obligations (CBLOs), these securities also have very low credit risks. Due to their low yields, CBLOs are only suitable for investments lasting a very limited time, such as a single day, a few days, or a few weeks.


The highest rated corporate bonds or commercial papers are next in the hierarchy of credit risk (e.g. AAA, A1 rated securities). Investors should be aware that bonds, non-convertible debentures (NCDs), and commercial paper can all have their credit ratings reduced, even if they were given the highest credit rating. A downgraded bond’s price will decrease. Some securities inside the AAA/A1 rated papers may have a decreased likelihood of a downgrade or default. This post will talk about banks and PSU funds that invest in fundamentally high-credit-quality assets.


What Are PSU And Banking Funds?


As stated above Banking and PSU Funds are a subcategory of debt mutual funds. Because of the high creditworthiness of the companies in which these funds invest, many investors consider them as best debt mutual funds. According to SEBI’s regulations on mutual fund classification, Banking and PSU Mutual Funds must invest at least 80% of their assets in debt instruments issued by these institutions. When compared to a number of other debt fund categories, Banking and PSU Funds are considered less risky. Many Banking and PSU Funds have given decent returns historically, UTI Bankintg & PSU  Debt Growth Direct Plan has given a return of 9.9 % in the past one year (as on 3 August, 2022).

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Why Are Banking And PSU Mutual Funds Considered A Relatively Safe Investment?


Banks, PSUs, and PFI typically issue debt and money market instruments with excellent credit quality. PSUs are government-owned businesses in which the government holds a majority stake. As a result of government support, PSUs have a quasi-sovereign status. Investors should be aware that assets with sovereign status, such as debt or money market instruments, do not carry much credit risk. PSUs have a very low credit risk because they are quasi-sovereigns. PFIs are also governmental organizations; they may be owned by the federal or state governments. PFIs have a similar quasi-sovereign status to PSUs.


Due to their regulation and typically high capitalization levels, banks—both public and private—benefit from high credit ratings. Most banks have excellent credit worthiness. Investors should be aware that PSU and banking funds will not finance non-banking financial companies (NBFCs), which may have a range of credit ratings. Because of the high credit worthiness of the investee companies, Banking, and PSU Mutual Funds are considered as relatively safe in comparison to equity mutual funds and even safer than certain other categories of debt mutual funds.


Investment Policy of Banks and Public Sector Funds


SEBI has not imposed any restriction on the duration of debt instruments in which the Banking and PSU Funds invest, SEBI only wants to ensure that the issuers of the underlying debt instruments in case of Banking and PSU Funds are banks, PSUs, and PFIs. The fund manager has the freedom to invest in the debt instrument irrespective of their tenure. Typically, Bank and PSU Fund’s managers will invest in short to medium-term securities using an accrual approach (keep till maturity), but occasionally, if they have a positive outlook on interest rates, they may also invest in longer-term instruments.

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Investors need to be aware that a fixed income security’s interest rate sensitivity is determined by length. Bond prices and interest rates are inversely related; when interest rates rise, bond prices decline and vice versa. Compared to shorter duration bonds, longer duration bonds will experience a more negative price impact from unfavourable interest movement. As a result, debt funds with longer durations are typically more volatile than those with shorter durations. The lengths of various banking and PSU funds may vary. Investors should ensure they are comfortable with the interest rate risk profile of these funds by reviewing the duration profile of the scheme portfolio (included in the monthly fund factsheet published on the AMC websites). If necessary, you should seek the advice of a financial expert. Click here if you want to know more about performance of debt mutual funds.


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Did you know? You can now invest in mutual funds on Kuvera without paying any commission or brokerage:

Step 1: Download the Kuvera app or visit our website.

Step 2: Create your account on Kuvera by completing the mandatory KYC procedure. This will hardly take a few minutes. Once that’s completed,  select the ‘Invest’ option on our homepage after which you can select ‘Mutual Funds’ and ‘Banking and PSU Funds’.

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Step 3: Kindly go through the list of all zero-commission direct plans of Banking and PSU Funds to start investing.


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