Your questions – Mutual funds: For liquid funds, check the expense ratio, performance and credit quality of the portfolio

For an investment horizon of three months or more, also consider very short-term funds, which with a slightly higher portfolio maturity / duration (3-6 months), offer higher returns.

Is it safe to keep my emergency funds in liquid funds now because the returns are very low?
—AK Dharamraja
Liquid funds invest in debt and money market securities with maturities of up to 91 days. Therefore, their returns would generally follow prevailing short-term interest rates. In addition, due to the short-term nature of the instruments held, any impact of changes in interest rates on their valuation is negligible. Interest rates and bond prices share an inverse relationship.

In terms of the credit quality of the underlying portfolios, liquid funds invest mainly in securities rated AAA and equivalent. Recently, due to an increase in short-term interest rates in the bond market, liquid fund returns have improved slightly. While investing, check the portfolio’s credit quality, expense ratio and performance. For an investment horizon of three months or more, also consider very short-term funds, which, with a slightly higher maturity / portfolio duration (3-6 months), offer higher returns.

What should be the ideal period of holding in a dynamic bond fund and is investing in such funds risky in the current situation?
—Suraj Gangwar
Dynamic bond funds have the ability / flexibility to invest in bonds or government securities through duration tranches depending on the views of the fund manager. If the manager believes that long term interest rates would fall, he may invest in long term government bonds / securities to benefit from lower interest rates. Conversely, if he believes that interest rates should rise, he may reduce the duration of the portfolio. It is sometimes known that managers also accept credit calls in these strategies, that is, they invest in lower rated bonds to obtain higher returns. Given the great flexibility of the mandate, dynamic bond funds can be considered “all weather” debt funds and can be held for long periods such as three to five years or even longer. While investing, it is necessary to assess the skills of the manager; one indicator could be to understand how well they have gone through various interest rate cycles in the past. It should also take into account the credit quality of the underlying portfolio and whether this matches its point of view, the expense ratio and the exit charge structure (if applicable).

The author is Director, Investment Advisory, Morningstar Investment Adviser (India). Send your questions to [email protected]

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About Christopher Easley

Christopher Easley

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