Is it safe to keep my emergency funds in liquid funds now as the returns are very low?
—A K Dharamraja
Liquid funds invest in debt and money market securities with maturities of up to 91 days hence their returns would typically track prevailing short term interest rates. Further due to the short-term nature of instruments held, any impact of interest rate changes on their valuations is negligible. Interest rates and bond prices share an inverse relationship.
In terms of credit quality of underlying portfolios, liquid funds invest mainly in AAA and equivalent rated securities. In recent times, due to an increase in short term interest rates in the bond market, yields on liquid funds have improved marginally. While investing, check the credit quality of the portfolio, expense ratio and yield. For an investment horizon of three months or more, consider ultra short term funds as well, which with a slightly higher portfolio maturity / duration (3-6 months), offer higher yields.
What should be the ideal period of holding in a dynamic bond fund and is investing in such funds risky in the current situation?
Dynamic bond funds have the ability / flexibility to invest in bonds or government securities across duration buckets based on the fund manager’s views. If the manager holds a view that long term interest rates would move down, he can invest in bonds / government securities with long duration to benefit from a fall in interest rates. Conversely, if he holds a view that interest rates are expected to move up he can reduce the duration of the portfolio. At times, managers have been known to take credit calls as well in these strategies, i.e., investing lower rated bonds to earn higher yields. Given the broad flexibility in mandate, dynamic bond funds can be considered as ‘all weather’ debt funds and can be held for long periods such as three to five years or even more. While investing, one needs to assess the skill sets of the manager; one indicator could be to understand how well they have navigated various interest rate cycles in the past. One should also consider the credit quality of the underlying portfolio and whether that aligns well with one’s views, the expense ratio and exit load structure (if any).
The writer is director, Investment Advisory, Morningstar Investment Adviser (India). Send your queries to firstname.lastname@example.org