If you are interested in investing in mutual funds, one type funds that you may consider are debt funds. Generally, these funds invest in interest securities, such as bonds and government securities.A majority of debt funds adopt a combination of two strategies based on the market conditions and expectations. They are accrual and durationstrategies.
The accrual fund strategy aims to invest in well-managed companies that may have lower credit ratings. The objective is to benefit from the improvement of their credit rating to earn profits.
A fund that follows the duration strategy aims to earn returns through interest rate movements. The fund buys and sells securities with a particular maturity date.
Features of accrual funds
- Such funds focus on interest income through its bond holdings. In addition, these funds may earn some capital gains due to an increase in the bond price.
- Accrual funds adopt a buy and hold strategy with little trading. This means that they hold their investments until maturity to earn interest income.
Types of accrual funds
- Credit opportunity funds
These funds focus on identifying mismatches between the current bond rating and its fundamentals.
- Corporate bond funds
Such funds invest in high-grade bonds and do not assume credit risk. Furthermore, the focus is not on identifying amismatch between fundamentals that may change in the bond and its credit rating.
Choosing one strategy over the other primarily depends on the risks you are willing to assume and expected returns.Here are three factors that may help you make an informed decision.
- Credit risks
Accrual funds are exposed to risks because these buy securities of companies with a lower credit rating. However, these companies are fundamentally strong and provide the scope for delivering greater returns. Fund managers aim to profit from the improved credit ratings as these well-managed companies perform better over a period of time. The increase in the ratings will result in a price rise enabling the fund to earn returns. However, if the credit ratings are further downgraded, you face the risk of seeing lower returns.
- Regular income
Several financial experts recommend investing in fixed income funds instead of bank deposits. They advise you to shift some portion of your fixed deposits to income funds to earn higher returns. Accrual funds provide this opportunity because the investments have a long-term duration. These funds aim to capitalize on the interest income earned over the longer time duration.
- Interest rate risks
Accrual funds do not take an interest rate risk and generally invest in short to medium-term bonds.The accrual strategy focuses on corporate bonds that offer higher yields. The objective is to earn returns through the higher accrual of interest through its holdings. The fund does not aim to make capital gains through an increase in the bond prices. Investment decisions are based on credit analysis to identify companies that offer higher yields. Generally, accrual funds include bonds with a maturity between one and three years.
There are many instruments in the market where you may invest your money. It is recommended you make an investment decision based on your personal goals and risk appetite.