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Banking and PSU Debt Funds are funds that primarily lend to Public Sector Companies and Banks. Given that Banks and Public Sector Units have a negligible chance of default, this makes Banking and PSU Debt Funds a fairly safe investment.
Debt Funds are considered worthwhile investments. They not only help in achieving your financial goals and targets. They can also contribute to adding to an investor’s income. However, Debt Funds come with their own set of benefits and disadvantages.
Debt Funds have risks. There are two types of risk that you may need to consider while investing. The risk of default is commonly referred to as credit risk and then there is interest rate risk.
When the borrower fails to meet the obligations of a Debt Fund as per the agreed terms, it leads to credit risk. Interest rate risk arises due to fluctuating interest rates. Debt Funds and interest rates have an inverse relationship. When interest rates rise, Debt Funds do not give higher returns.
However, some funds have low chances of default but are still prone to interest rate risk. Such funds are Banking and PSU Debt Funds.
As per SEBI’s new fund classification guidelines, the Banking and PSU Debt Fund meaning states that these funds have to invest 80% of their assets/corpus in instruments issued by banks, public sector undertaking (PSU), and public financial institutions (PFI). Simply by this aspect, these funds are considered to have better credit ratings/ quality compared to most other Debt Funds.
Features of Banking and PSU Funds
- Credit Quality: One of the most prominent features of Banking and PSU Debt Funds is the credit quality associated with these funds. Given the very nature of the issuers of the underlying debt securities, the credit quality of such funds is considered superior to most Debt Funds in the market.
Banks on the other hand are extensively regulated by the RBI and have to at all times have adequate capital. A large number of banks are also Public Sector Banks. Both these factors make debt issued by banks enjoy high credit ratings. - Risk Factor: Debt issued by Public Sector Units and Institutions have the Government as a majority shareholder. This makes them quasi-sovereign, making debt issued by such entities carrying little to no risk.
- Favorable Returns: Unlike other Debt Funds, Banking and PSU Debt Funds have no restriction on duration. This gives the fund managers the flexibility to take calls that best maximize returns.
- Bond prices have an inverse relationship with interest rates – Bond prices fall when interest rates go up and vice versa. So having flexibility on duration helps the fund manager to maximize returns, as and when duration and interest rates turn favorable to the instruments in the fund.
Taxation of Banking and PSU Funds
Any returns made by the Banking and PSU Debt Funds will be taxed.
Any profit booked within the first 3 years of investment, will be added to the income and taxed according to the income tax slab one falls in.
Profits booked after 3 years of investment will attract long-term capital gain of 20% post allowing for benefits of indexation. This makes the returns on such funds highly tax-efficient after an investment period of 3 years.
Who should invest in Banking and PSU Funds
- Banking and PSU Funds are a good option for investors who will remain invested for more than 3 years.
- Investors who are risk-averse but will look at avenues other than a Fixed Deposit.
- Investors who look at fixed income and capital appreciation.
Conclusion
Banking and PSU Debt Funds can be considered as an alternative to fixed deposits if an investor is looking for better returns and has a longer investment horizon. These funds have been known to give anywhere between 5% to 7% returns. Being Debt Funds, the returns gained on such investments also enjoy the benefits of indexation on the cost of acquisition. This makes these more tax-efficient compared to bank fixed deposit returns if the holding period is more than 3 years.
Frequently Asked Questions (FAQs)
1. What are Banking and PSU Funds?
Banking and PSU Debt Funds are Mutual Funds mandated by SEBI to invest 80% of their corpus in debt instruments of banks, public sector undertakings, public financial institutions.
2. Are Banking and PSU Debt Funds Good?
Banking and PSU Debt Funds are considered low-risk investments as credit ratings of their debt are fairly high. They carry a negligible risk of default but can be subject to some risk on interest rates depending on prevailing market interest rates.
Overall, Banking and PSU Debt Funds are considered fairly low-risk investments that give tax-efficient returns when held for longer than 3 years.
3. Do Banking and PSU Funds Have an Exit Load?
Most Banking and PSU Funds do not have an exit load.
4. Can we Invest via SIP in Banking and PSU Funds?
Yes, it is possible to invest via SIP in Banking and PSU Funds.
5. Is There a Lock-in Period for Banking and PSU Funds?
There is no such lock-in period for any amount invested in Banking and PSU Funds. Investors can liquidate at any time of their choice.
