We have discussed earlier that, you should invest in debt funds according to your investment tenure and risk appetite. In this article, we will discuss how to select debt mutual funds. The two important parameters that you should understand when selecting debt funds are Duration and Credit Risk. You should always match your investment needs and risk appetite to these two parameters when investing in debt funds and make informed investment decisions.

Duration and Investment Tenure

We had discussed Macaulay Duration in the chapter, Categories of Debt Mutual Fund Schemes. Macaulay Duration depends on the maturity profile of the Scheme. Longer the maturity, longer will be the Macaulay Duration. Different debt fund categories have different maturity / duration profiles. Longer duration funds are more volatile with respect to interest rate risk compared to shorter duration funds. You should select funds of certain duration profiles based on your investment tenure. If you have long investment tenures, you can invest in longer duration funds. If you have short investment tenures, you should invest in shorter duration funds. The table below shows examples of how to choose debt funds based on your investment tenures

Investment Tenure	Duration Profile	Fund category examples
Short (less than 1 year)	Less than 1 year	Overnight, liquid, ultra-short duration funds
Medium (1 to 3 years)	1 year to 3 years	Low, money market, short duration funds
Long (More than 3 years)	More than 3 years	Long duration, Dynamic bond, Gilt funds

Disclaimer: Examples above are purely illustrative and should not be construed as investment recommendation. You should consult with your financial advisor before investing

Please note that fund category examples for different investment tenures and duration profiles are not exhaustive. Fund categories like Corporate Bond Funds, banking and PSU Funds etc. may have different duration profiles depending on prevailing yields. Based on your investment tenure, you should select the appropriate schemes after checking the duration profile from the fund factsheet.

Duration and Risk Appetite

As mentioned above, longer duration funds are more volatile than shorter duration funds. If you have low risk appetite, then you should invest in short duration funds. If you have higher risk appetite you can invest in longer duration funds which are more volatile – longer the duration, higher the volatility. The table below shows examples of how to select debt funds based on your risk appetite.

Disclaimer: Examples above are purely illustrative and should not be construed as investment recommendation. You should consult with your financial advisor before investing

Please note that fund category examples for different risk profiles are not exhaustive. Each of the risk profiles can be fairly broad and subjective. Different investors in the same broad risk profile may have different risk appetites. For example in the moderate risk profile, some investors may have higher tolerance for volatility compared to other investors. If you have higher tolerance for volatility you can invest in longer duration funds like Dynamic Bond Funds; if you do not have higher tolerance for volatility you can invest in Short Duration Funds. Further please note that within a fund category, different schemes may have different risk profiles. Refer to the scheme’s Riskometer to know the scheme’s profile before investing.

You should know that, long duration funds usually give higher yields than short duration funds due to the shape of the yield curve. You should evaluate risk / return trade-off and make informed decisions based on your risk appetite.

Credit risk

Credit risk is the risk of non-payment of interest and / or principal by the issuer (borrower). Credit rating agencies assign ratings to different debt and money market instruments. Lower rated papers give higher yields than higher rated papers. Some fund managers may invest in lower rated papers to capture higher yields. Some investors may be comfortable with higher credit risks depending on their risk appetite. If one or more bonds in your scheme portfolio defaults, you may suffer a permanent loss. If you want to avoid credit risk, you should always invest in high credit quality schemes e.g. Corporate Bond Funds, Banking and PSU Funds, Gilt Funds etc. You can check the credit quality of a scheme in the fund factsheet.