Banking and PSU debt funds are often called as the best alternative to bank deposits. These schemes mostly invest in bank certificates of deposits or bonds and debentures of public sector companies. According to the Sebi definition, the banking and PSU debt funds are open-ended debt schemes predominantly investing in debt instruments of banks, public sector undertakings and public financial Institutions.
These schemes generally invest in instruments with reasonably high liquidity and low average maturity. The banking and PSU debt mutual fund category has generated an average return of 10.01 per cent in the last one year. These schemes have two ways of generating returns. One, the bonds and debentures held in the portfolio provide accrual income from the coupon. Two, the duration investments generate returns in a falling interest rate scenario.
Banking and PSU funds face risks from the interest rate movement. In times of hardening or flat interest rates, they might do badly. These schemes are ideal for investors looking for higher returns than bank deposits, with some risk. In the current market situation, these schemes can do very well like the other bond funds.
“These schemes are highly liquid and invest in the top rated instruments. The risk of default is very less in these schemes. However, they can get hit by the interest rate movements. If you are investing for one to three years, you can choose these schemes. They have lower risk, compared to dynamic bond funds, credit risk funds …,” says Neeraj Chauhan, CEO, The Financial Mall.
Lately, many debt mutual fund managers have been recommending banking and PSU debt funds. Though many of them claim the category is safer than many other debt categories, they are not entirely risk free. “Don’t make the mistake of thinking that these schemes aren’t risky. Liquid funds continue to be our top preference when we speak about an alternative to bank savings account,” says Chauhan.
The profits in banking and PSU debt funds if held for more than three years, are treated as long-term capital gains. They attract a tax of 20 percent with indexation benefit. If you redeem your investments within three years from the date of purchase, short-term capital gains would be added to the income and taxed as per the income tax slab applicable to the investor.