Why Banking and PSU Debt Funds Are Grabbing Investors' Attention

Jun 12, 2020

Listen to Why Banking and PSU Debt Funds Are Grabbing Investors' Attention

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Inflows in credit risk funds slid once again May registering an outflow of Rs 5,173 crore during the month, according to the latest data from AMFI. A combination of multiple rating downgrades and defaults in the past followed by the more recent Franklin Templeton shock caused wary investors to shun this once attractive category of debt fund.

Credit risk-oriented funds witnessed heavy redemptions over the last year due to downgrades and defaults causing significant erosion of investors' wealth. To meet the redemption demand debt funds had to liquidate their high-rated papers leading to higher concentration of low-rated (illiquid) securities. This led to further escalation of liquidity crunch for AMCs.

Risk aversion among investors has risen because credit risk is likely to intensify amid the pandemic and the resultant risk to business operations. In such a scenario, investors have flocked to safer categories of debt funds.

Banking and PSU debt fund is one category that has emerged as a winner amid the debt crisis.

The category witnessed inflows of Rs 8,873 crore in May, the highest since April 2019. The number of folios in the category surged from around 85,000 in April 2019 to around 2 lakh in May 2020.

Graph: Inflows in Banking & PSU Debt Funds soared sharply in the last 2 months

Data as on May 31, 2020
(Source: AMFI)

Banking and PSU debt funds are mandated to invest in a minimum 80% of its assets in debt instruments of banks, Public Sector Undertakings, and Public Financial Institutions.

Portfolios of Banking and PSU Funds mainly comprise of government and quasi-government securities along with some exposure to top names in the banking industry. These companies enjoy high-credit rating and government backing which makes it highly liquid and less prone to credit risk.

As on May 2020, Banking and PSU Funds held 80.1% of its assets in AAA (highest rating) rated instruments, 9.4% in sovereign rated instruments, around 5% in cash equivalents. The exposure to low rated instruments was limited to around 5%.

Investment is predominantly in top-rated PSUs such as Bank of Baroda, EXIM, Housing & Urban Development Corporation, Indian Oil Corp, Indian Railway Finance Corp, LIC Housing Finance, NABARD, NHAI, NHPC, NTPC, Power Fin Corp, Power Grid Corp, Rural Electrification Corp, SIDBI, among others.

(Image Source: photo created by freepik - www.freepik.com)

Apart from liquidity and better safety, its good performance track record has made it attractive for investors. The RBI has cut policy rate by a cumulative 250 basis points since 2019 while maintaining accommodative stance as long as necessary to revive growth. In the falling interest rate scenario, these funds benefitted from capital appreciation.

Table: Banking and PSU Debt Fund's returns has attracted investors

Scheme Name Absolute (%) CAGR (%)
6 month 1 year 3 year 5 year
Edelweiss Banking and PSU Debt Fund 8.75 14.99 9.77 9.19
IDFC Banking & PSU Debt Fund 6.26 12.35 9.33 8.67
Axis Banking & PSU Debt Fund 5.27 11.06 9.16 8.84
SBI Banking and PSU Fund 6.01 11.36 9.03 8.90
Franklin India Banking & PSU Debt Fund 5.51 10.93 8.84 9.04
LIC MF Banking & PSU Debt Fund 5.16 10.51 8.83 8.54
Nippon India Banking & PSU Debt Fund 6.34 12.35 8.77 9.05
Kotak Banking and PSU Debt Fund 5.77 11.33 8.70 9.00
PGIM India Banking & PSU Debt Fund 5.81 11.41 8.54 8.80
DSP Banking & PSU Debt Fund 6.46 12.10 8.53 8.99
Category Average 5.65 11.09 8.42 8.69
Crisil 1 Yr T-Bill Index 3.99 7.70 7.18 7.16
Data as on June 11, 2020
(Source: ACE MF)

Should you consider investing in Banking and PSU Debt Funds?

Interest rates on small savings schemes and Bank deposits have been declining since RBI started reducing policy rates. So if you are willing to take slightly higher risk for higher returns, Banking and PSU funds can be considered as a worthy alternative to these investments.

Stick to funds with good performance track record and invest in a fund house that follows stringent systems and risk management process.

Do note that while credit risk in this category is low, it is prone to interest rate fluctuation. When interest rates rise, these funds generate lower returns.

If you are not willing to take higher risk, consider investing in low duration funds such as a pure liquid fund and/or overnight funds.

Most of the rally at the longer end of the yield curve has already come about since the time RBI started reducing policy rates. So, the longer end of the yield curve thus could prove less rewarding and risky (may encounter high volatility) in the foreseeable future.

You'll be better off deploying your hard-earned money in shorter duration debt mutual funds. But approach even short-term debt funds with your eyes wide open -- pay attention to the portfolio characteristics and quality of the scheme.

To select a scheme, essentially assess your risk appetite and investment time horizon, plus factors such as:

  •  The portfolio characteristics of the debt schemes;

  •  The average maturity profile;

  •  The corpus & expense ratio of the scheme;

  •  The rolling returns;

  •  The risk ratios;

  •  The interest rate cycle; and

  •  The investment processes & systems at the fund house

At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.

Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.

If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!


Warm Regards,
Divya Grover
Research Analyst


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