Best Banking & PSU Debt Funds to Invest in India

But first, let's get to know the category in detail...

What are Banking & PSU Debt Funds?

Banking & PSU Debt Funds allocate a minimum of 80% of their assets to top-rated corporate debt instruments issued by Banks, PSUs (Public Sector Undertakings), and PFIs (Public Financial institutions). These Instruments issued by Banks, PSUs, and PFIs are known for their strong credibility and liquidity compared to private issuers and are, therefore, relatively safer.

While these funds primarily invest in a specific segment, they have the flexibility to diversify their exposure across the yield curve. The decision regarding portfolio duration lies with the fund manager, who evaluates various micro and macroeconomic factors to determine the most suitable duration strategy.

Although there are no fixed limits on portfolio duration, most Banking & PSU Debt Funds typically maintain durations ranging from 2 to 5 years. This makes Banking & PSU Debt Funds moderately sensitive to interest rate fluctuations, especially in uncertain and rising interest rate environments. However, they can potentially benefit from regular coupon payments and may employ a partial accrual strategy to mitigate volatility during rising interest rate periods.

While Banking & PSU Debt Funds primarily focus on instruments issued by Banks, PSUs, and PFIs, which are known for their higher credibility compared to private issuers, it's essential to acknowledge that not all of these funds can be considered entirely risk-free. Hence, investors should not overlook the associated credit risk with these investments.

Does it make sense to invest in Banking & PSU Debt Funds now?

In its last policy meeting held in August 2023, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) chose to maintain the status quo by keeping interest rates unchanged, citing lacklustre monsoon conditions and anticipations of temporary inflationary pressures expected during the latter half of the year. The MPC has resolved to remain vigilant and assess the emerging circumstances going ahead.

Notably, the RBI's gradual implementation of a cumulative 250 basis points (bps) interest rate hike is working its way into the economy. Although the margin of safety has increased after a series of rate hikes, debt fund investors still need to be cautious about the quality of instruments they are investing in and prefer safely managed funds that carry lower interest rate risk and, at the same time, focus on high credit quality instruments.

Banking & PSU Debt Funds invest in high-quality debt instruments and carry an average maturity of 2-5 years. Therefore, in the current market environment, Banking & PSU Debt Funds can potentially offer stability without exposing the portfolio to undue risks.Top of Form

[Read: RBI Keeps Policy Rates Unchanged Again! Here's How to Approach Debt Mutual Funds Now]

Who should consider investing in Banking & PSU Debt Funds?

Investors looking for a relatively stable, safer, and liquid scheme in the debt mutual fund category can consider investing in the Banking & PSU Debt Funds as a viable choice. These funds can offer the similar benefit of Corporate Bond Funds (that invest in top-rated instruments of private issuers) but at lower credit risk. These funds are suitable for individuals seeking exposure to highly-rated bond instruments issued by Banks, PSUs, and PFIs, with an investment horizon of at least 2 to 3 years. It is important to note that while Banking & PSU Debt Funds have the potential to generate higher returns than bank fixed deposits, they do carry a slightly higher level of risk.

How are Banking & PSU Debt Funds taxed?

After the passage of the Finance Bill 2023, Debt Mutual Funds are now at par with bank fixed deposits in terms of taxation. The realised capital gains made on Debt Mutual Funds, whether short-term (less than 36 months) or long-term (36 months or more), are now taxed as per the tax slab applicable to an individual investor.

The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds.

Which are the best Banking & PSU Debt Funds to invest in 2023?

Best Banking & PSU Debt Funds to invest in 2023 #1: Bandhan Banking & PSU Debt Fund

Launched in March 2013, Bandhan Banking & PSU Debt Fund is the erstwhile IDFC Banking & PSU Debt Fund that has recently undergone a change in name after the takeover of IDFC AMC by Bandhan AMC. The fund predominantly focuses on instruments with maturities of 2 to 3 years, with a minor allocation to instruments falling within the 3 to 5 years maturity range. It strategically places a significant portion of its portfolio in bonds with short to medium-term residual maturities, enabling it to actively leverage accrual opportunities aligned with its investment objectives.

The fund periodically makes adjustments to the allocation of investments in different fixed-income instruments and manages the maturity profile of its portfolio in response to factors such as interest rates, inflation, market dynamics, liquidity conditions, and the fund manager's macroeconomic assessment.

Best Banking & PSU Debt Funds to invest in 2023 #2: HDFC Banking & PSU Debt Fund

Launched in March 2014, HDFC Banking & PSU Debt Fund has a commendable track record of over 9 years, during which it has grown at a compounded annualised return of 8%. The fund targets stable returns but carries a moderately high interest rate risk and a substantial amount of credit risk as well. It primarily emphasises on issuers with a high credit rating and typically invests in AAA-rated debt securities with maturities falling within the 3-year to 5-year range.

The investments in residual maturity bonds within shorter maturity buckets help the fund take advantage of the accrual opportunities in this space. The fund manager enjoys the flexibility to modify the portfolio's duration as per their judgment and expectations regarding interest rate shifts, current liquidity situations, and other macroeconomic elements.

Best Banking & PSU Debt Funds to invest in 2023 #3: Aditya Birla SL Banking & PSU Debt Fund

Launched in May 2008, Aditya Birla SL Banking & PSU Debt Fund aims to generate reasonable yield for investors at lower levels of risk while maintaining sufficient liquidity in the portfolio. While picking securities for the portfolio, the fund manager focuses on credit quality, which is an important parameter for making an investment decision. The fund typically holds short to medium-term securities and generates a significant proportion of the total returns in the form of income yield or accruals. The fund management determines the general maturity range for the portfolio after considering prevailing political conditions, the macroeconomic environment (including interest rates and inflation), the performance of the corporate sector, overall market liquidity, and other considerations in the economy and markets.

The fund has a track record of generating above-average returns by prudently investing in sectors and issues of debt securities that have the potential to provide consistently superior yields at low levels of risk. It follows a diligent identification process for securities to pick the right debt and money market investment, and that too, at the appropriate time.

Best Banking & PSU Debt Funds to invest in 2023 #4: Axis Banking & PSU Debt Fund

Launched a decade ago in June 2012 as a Banking debt fund, the Axis Banking & PSU Debt Fund was initially launched with a mandate of investing predominantly in Banking debt instruments. However, in November 2016, the fund added an element of PSUs in its name and portfolio, making it one of the primary schemes with the Banking & PSU Debt mandate. The fund aims to generate stable returns at a lower credit risk while keeping the portfolio duration in check, which also helps it control interest rate risk. It focuses on instruments issued by high credit quality issuers and is usually invested in AAA-rated debt securities within the 3-year maturity bucket.

The investments in residual maturity bonds within this maturity help the fund take advantage of the accrual opportunities in this space. The fund manager has the flexibility to switch the portfolio duration depending on his views on the macroeconomic conditions, interest rate directions, systemic liquidity, and other factors.

Best Banking & PSU Debt Funds to invest in 2023 #5: ICICI Pru Banking & PSU Debt Fund

Launched in January 2010, ICICI Pru Banking & PSU Debt Fund invests predominantly in debt instruments with AAA credit rating profiles. It also takes tactical allocation in government securities. The fund seeks to maintain a moderate duration in 1 to 3 years range with limited active management. However, depending on market conditions and opportunities available, the modified duration of the fund may go above 3 years. The fund also aims to generate accrual income by following the hold-till-maturity approach for some portion of the portfolio.

ICICI Pru Banking & PSU Debt Fund follows a partially buy-and-hold strategy, which aims to generate optimum yield with a decent credit quality portfolio. While selecting securities, the fund undertakes rigorous, in-depth credit evaluation to mitigate the risks. In addition, the investment team studies the macroeconomic conditions, including the political, economic environment and factors affecting liquidity and interest rates and accordingly positions the portfolio.

This concludes our compilation of the top five best Banking & PSU Debt Funds to invest in India. Remember that though Banking & PSU Debt Fund are relatively safe, they cannot be considered risk-free. Therefore, before picking the best Banking & PSU Debt Fund for the portfolio, investors must thoroughly understand the risks involved and make an informed decision.

[Read: 5 Best Debt Mutual Funds to Invest in 2023]

Disclaimer:

The schemes mentioned above are selected on the basis of PersonalFN's SMART Score, which considers various quantitative and qualitative parameters to arrive at fundamentally sound and reliable mutual fund schemes. These schemes may or may not be suitable for you. Hence, it is necessary that you understand your risk appetite and suitability well in case you consider investing in any of these funds. If unsure, do consult your SEBI registered investment advisor.  

This write-up is for information purpose and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully before investing.

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.