Debt fund portfolio management: Best practices for creating a well-diversified debt fund portfolio

For investors who are risk-averse and concerned about stock market volatility yet aim to get better returns than traditional investments, debt mutual funds represent an opportunity. But what if you want to create an optimal portfolio that would provide you with stability in difficult times without having to sacrifice potential gains? The key is diversifying your debt fund portfolio using best practices that draw on time-tested investment techniques which not only provide financial security but also opportunities for wealth generation. Let’s analyse each of these practices in detail.

  1. Invest in different types of debt funds

Most experts recommend investing in different debt funds types, such as government bonds, corporate bonds, treasury bills, and money market instruments. However, note that each type of debt instrument has its own set of risks and rewards, so it’s important to understand the differences between them before investing. For example, government bonds tend to offer lower returns but are safer than corporate bonds, which usually have higher yields but more risk associated with them. As such diversify your portfolio as per your risk tolerance.

  1. Diversify across funds with different maturity dates

This means investing in different debt funds such as overnight funds (1-day maturity), short term debt funds (1-3 years), medium-duration funds (3-4 years), and so on. This will help spread out the risk associated with each security and maturity while allowing you to benefit from potential gains when certain markets or maturities perform well.

  1. AMC-level diversification

When building a diversified debt investment portfolio, it’s important to diversify not only the individual funds you invest in but also the asset management companies (AMCs) that manage those funds.

Don’t invest in all funds from a single asset management company. Spread out your debt fund investments among several different AMCs. Every AMC uses different methods for managing risk and debt portfolios. Spreading out your investments will ensure you get exposure to various strategies and approaches to managing debt portfolios.

  1. Take a three-bucket approach

The most effective way to create a well-diversified debt mutual fund portfolio is by taking a three-bucket approach.

  1. Cash bucket

Purpose: Focuses on safety and liquidity, hence, serves as a cover for emergency corpus needs or immediate cash requirements.

It should include investments such as overnight funds and liquid mutual funds, which have low credit and interest risk products along with high liquidity. A good rule of thumb for this bucket is to invest what you would need to cover your expenses for 3-6 months.

  1. Core bucket

Purpose: Offers decent return with minimal risk. Should form the majority of your debt fund portfolio – more than 50% (if you are risk averse).

This includes investments like corporate bond funds and short-term, medium-term, and low-duration funds. These products offer relatively higher returns while still offering a hedge against risk.

  1. Alpha bucket

Purpose: Has a higher risk but higher return potential than the cash and core bucket investments.

You can invest in dynamic bond funds, debt-oriented hybrid funds, or credit risk funds. You should allocate your investments with thorough research because these instruments carry higher risks.

Note that creating a well-diversified debt fund portfolio is an essential part of achieving financial success. Thus, it is important to select each debt fund carefully and consider factors like the amount of risk you are willing to take, your goals, objectives, time horizon, liquidity needs, diversification, and portfolio rebalancing.

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