How to Build a Stable Debt Portfolio

Introduction

The creation of a portfolio involves the allocation of funds to equity and debt assets. The division of funds between the two types of assets depends upon the goal of the investment portfolio in question and the factors associated with it. Once you understand the intent behind your portfolio creation, you have to decide the kind of risk they are willing to take, the tenure of investments, the level of volatility you are comfortable with, the level of returns they expect from their investments and so on. These factors determine the equity and debt requirements of a portfolio. The goal of debt instruments is to provide stability to the overall portfolio, with the division of funds generally being on a 50–50 basis.

Steps to build a stable debt portfolio

• The first step towards a stable debt portfolio is to understand why one needs debt funds and instruments in their portfolio. The answer to this will determine the safety and liquidity of the debt portfolio.

• The second step is to understand the features of the different types of debt funds . The different types of debt funds have different types of risks. Understanding these risks would help investors decide the kind of debt funds they want to invest in and the amount they are willing to invest.

• The evaluation of any particular fund involves understanding the fund's expense ratio, the quality of credit it has, the average weighted maturity of the fund, and the type of maturity of the fund.

• The liquidity of a fund is an important consideration. That means that when a fund is redeemed, it should have sufficient assets to liquidate with little to no impact costs. That means the liquidation of some assets should not significantly increase the rest of the assets' risk factors.

• Investments should not be made based solely on the past performance of debt funds. You must also pay attention to the type of risk associated with it. You may want to consult a financial advisor before making any investments.

• Layering is also an essential concept in a debt fund portfolio. The idea is to divide the portfolio into two or more categories, with one core portfolio consisting of the bulk of the assets and two or more satellite portfolios.

• The function of a core portfolio is to provide a safety net for the rest of the investments. A core portfolio generally includes the fixed income securities, usually internally layered into a mix of public Provident Fund (PPF), Employee Provident Fund (EPF), small savings schemes and RBI bonds .

• One of the satellite portfolios is generally dedicated towards emergency requirements. Since the money from this portfolio may be required at any given moment of time with no notice at all, this portfolio generally consists of liquid funds and ultra short-term funds, which can be easily closed without incurring any significant penalty.

• Another satellite portfolio would likely be dedicated towards generating higher returns by taking advantage of market conditions. This portfolio would likely consist of dynamic bond funds, credit funds, non-convertible debentures, and gilt funds.

Conclusion

Debt fund investments are used to bring stability to portfolios. An investor must understand their risk appetite and the nuances of the different types of debt funds in order to create a stable debt fund portfolio suited to their needs.