In recent years, the decline in debt mutual fund investors has been alarming. Since 2020, folios in fixed income funds have dropped to 7.1 million from 8.1 million even as equity-oriented fund folios have skyrocketed to over 1.5 billion from 638 million. While the percentage of total MF assets to bank fixed deposits has risen to 31% in 2024 from 16% in 2020, the ratio of fixed income assets under management to bank deposits remains a paltry 7.5% as of October 2024.
For context, in the US, fixed income MF assets are at $6.16 trillion, about 31% of the $20 trillion in bank deposits. The contrast highlights the untapped potential of debt MFs in India’s household savings landscape.
Why the disparity?
Several factors have contributed to this trend, especially taxation changes that have reduced the appeal of debt MFs for institutional and high net worth individual (HNI) investors. Currently, institutions dominate fixed income AUM with a 64% share, while individual investors, mostly HNIs, account for 36%. Retail investors who have driven the meteoric rise in equity MFs through systematic investment plans are yet to experience the benefits of fixed income MFs.
For fixed income MFs to flourish, a real retail revolution is needed. Investors must understand the advantages these funds offer beyond taxation. Here are five compelling benefits of fixed income MFs for retail investors:
1. Liquidity that works for you
Unlike fixed deposits (FDs), where breaking it means paying penalties and losing or earning lower interest on the entire amount, fixed income MFs allow partial withdrawals without penalties. Need ₹1 lakh from your ₹5 lakh investment? No problem. Your remaining ₹4 lakh continues to grow undisturbed. Moreover, you can add to your existing investment whenever you have surplus cash, offering unmatched flexibility to manage short-term cash flow needs.
2. Deferred taxation for efficient growth
With fixed income MFs, you pay tax only when you redeem your investments. In contrast, taxes are imposed on the interest earned on FDs every year, even if you don’t withdraw the funds. Bonds too don’t give you an option but to pay taxes every year on the interest earned. By deferring taxation in fixed income MFs, all your returns stay invested and compound over time, saving you form tax hassles and enhancing overall returns.
3. Customisable cash flows
Fixed income MFs allow you to set up a systematic withdrawal plan (SWP) tailored to your needs. Whether it’s 3% p.a. or 6% p.a., you decide the cash flow. Plus, the tax efficiency of SWPs—where withdrawals consist of both capital and returns—reduces your tax liability while deferring taxes on the remaining investment. This flexibility and efficiency make them an excellent tool for predictable, tax-optimised cash flow.
4. Potential for higher returns
Fixed income MFs offer a variety of options – from low-duration funds to dynamic duration funds. Unlike FDs, they benefit from bond price movements, especially in a falling interest rate environment. Over the long term, this can translate to returns that exceed the interest earned by the portfolio.
5. Stability and predictability
If you think fixed income MFs don’t provide visibility of returns like FDs or bonds, think again. In addition to all the benefits explained, target maturity funds bring the best of all worlds. With fixed maturity and predictable returns, these funds aim to generate outcomes closely aligned with their portfolio yield at the time of investment.
Unlike bonds and FDs, they also allow flexible withdrawals at any time without penalties or constraints. This unique combination of stability and flexibility makes target maturity funds an excellent choice for investors seeking return visibility.
What are the risks?
Fixed income MFs also carry some risks, primarily credit risk (downgrades or defaults in bonds) and interest rate risk (falling bond prices when rates rise). However, these risks can be mitigated by selecting the right fund category aligned with your goals and risk appetite.
The case for fixed income MFs
The benefits of fixed income MFs over FDs and bonds make them an essential part of any diversified portfolio. They offer liquidity, tax efficiency, customisable cash flows, stability and the potential for higher returns—advantages that bank FDs and bonds cannot match.
Just as retail investors have embraced equity MFs through SIPs, it’s time for the same enthusiasm to transform the fixed income MF space. With a better understanding of their benefits, fixed income MFs can play a pivotal role in achieving financial goals efficiently.
Fixed income MFs sahi hai!
Radhika Gupta is MD & CEO at Edelweiss Asset Management Ltd. The views expressed are her own.
