Top Performing Banking & PSU Debt Funds to Add to Your Watchlist

Banking & PSU Debt Fund is a sub-category of debt mutual funds that offers investors the opportunity to earn stable returns from a portfolio of relatively stable, safer, and liquid debt securities. In this article, we have highlighted the best Banking & PSU Debt Funds that have consistently provided investors with superior risk-adjusted returns.

But first let's get to know the category in detail...

What are Banking & PSU Debt Funds?

Banking & PSU Debt Funds allocate a minimum of 80% of their assets to top-rated corporate debt instruments issued by Banks, PSUs, and PFIs. Instruments issued by Banks, PSUs, and PFIs, carry higher credibility and liquidity compared to private issuers, and are therefore relatively safer.

While these funds primarily invest in a specific segment, they have the flexibility to diversify their exposure across the yield curve. The decision regarding portfolio duration lies with the fund manager, who evaluates various micro and macroeconomic factors to determine the most suitable duration strategy.

Although there are no fixed limits on portfolio duration, most Banking & PSU Debt Funds typically maintain durations ranging from 2 to 5 years. This makes Banking & PSU Debt Funds moderately sensitive to interest rate fluctuations, especially in uncertain and rising interest rate environments. However, they can potentially benefit from regular coupon payments and may employ a partial accrual strategy to mitigate volatility during rising interest rate periods.

While Banking & PSU Debt Funds primarily focus on instruments issued by Banks, PSUs, and PFIs, that are known for their higher credibility compared to private issuers, it's essential to acknowledge that not all of these funds can be considered entirely risk-free, and thus, investors should not overlook the associated credit risk.

Does it make sense to invest in Banking & PSU Debt Funds now?

In its last policy meeting held in August 2023, the Monetary Policy Committee (MPC) of the RBI chose to maintain status quo and kept interest rates unchanged, citing lacklustre monsoon conditions and anticipations of temporary inflationary pressures expected during the latter half of the year. The MPC has resolved to remain vigilant and assess the emerging circumstances going ahead.

Notably, the RBI's gradual implementation of a cumulative 250 bps interest rate hike has been smoothly absorbed into the economy. Although the margin of safety has increased, after a series of rate hikes, debt fund investors still need to be cautious about the quality of instruments they are investing in and prefer safely managed funds that carry lower interest rate risk and at the same time focus on high credit quality instruments.

Banking & PSU Debt Funds invest in high quality debt instruments and carry an average maturity of 2-5 years. Therefore, in the current market environment Banking & PSU Debt Funds can potentially offer stability without exposing the portfolio to undue risks.

Who should consider investing in Banking & PSU Debt Funds?

Investors looking for a relatively stable, safer, and liquid scheme in the debt mutual fund category can consider investing in Banking & PSU Debt Fund. It can offer the benefit of Corporate Bond Funds (that invest in top-rated instruments of private issuers), but at lower credit risk. These funds are suitable for individuals seeking exposure to highly-rated bond instruments issued by Banks, PSUs, and PFIs, with an investment horizon of at least 2 to 3 years. It is important to note that while Banking & PSU Debt Funds have the potential to generate higher returns than bank fixed deposits, they also carry slightly higher risk.

How are Banking & PSU Debt Funds taxed?

After the passage of the Finance Bill 2023, Debt Mutual Funds are now at par with bank fixed deposits in terms of taxation. The realised capital gains made on Debt Mutual Funds, whether short-term (less than 36 months) or long-term (36 months or more), are now taxed as per the tax slab applicable to an individual investor.

The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds.

The Best Banking & PSU Debt Funds to Watch Out?

#1: Bandhan Banking & PSU Debt Fund

Launched in March 2013, Bandhan Banking & PSU Debt Fund is the erstwhile IDFC Banking & PSU Debt Fund that has recently undergone a change in name after the takeover of IDFC AMC by Bandhan AMC. The fund predominantly focuses on instruments with maturities of 2 to 3 years, with a minor allocation to instruments falling within the 3 to 5 years maturity range. It strategically places a significant portion of its portfolio in bonds with short to medium-term residual maturities, enabling it to actively leverage accrual opportunities aligned with its investment objectives.

It periodically makes adjustments to the allocation of investments in different fixed-income instruments as well as the maturity profile of the fund's portfolio in response to interest rates, inflation, market dynamics, liquidity conditions, and the fund manager's macroeconomic assessment.

Top portfolio holdings of Bandhan Banking & PSU Debt Fund

The securities quoted are for illustration only and are not recommendatory.
Holding in (%) as of August 31, 2023
(Source: ACE MF)

#2: HDFC Banking & PSU Debt Fund

Launched in March 2014, HDFC Banking & PSU Debt Fund has a commendable track record of over 9 years, during which it has grown at a compounded annualised return of 8%. The fund targets stable returns but carries a moderately high interest rate risk and a substantial amount of credit risk as well. It primarily emphasises on issuers with a high credit rating and typically invests in AAA-rated debt securities with maturities falling within the 3-year to 5-year range.

The investments in residual maturity bonds within shorter maturity buckets help the fund take advantage of the accrual opportunities in this space. The fund manager enjoys the flexibility to modify the portfolio's duration as per their judgment, expectations regarding interest rate shifts, current liquidity situations, and other macroeconomic elements.

Top portfolio holdings of HDFC Banking & PSU Debt Fund

The securities quoted are for illustration only and are not recommendatory.
Holding in (%) as of August 31, 2023
(Source: ACE MF)

#3: Aditya Birla SL Banking & PSU Debt Fund

Launched in May 2008, Aditya Birla SL Banking & PSU Debt Fund aims to generate reasonable yield for investors at lower levels of risk while maintaining sufficient liquidity in the portfolio. While picking securities for the portfolio, the fund manager focuses on credit quality which is considered an important parameter for making an investment decision. The fund typically holds short to medium term securities and generates a significant proportion of the total returns in the form of income yield or accruals. The fund management determines the general maturity range for the portfolio after considering prevailing political conditions, the macroeconomic environment (including interest rates and inflation), the performance of the corporate sector, and general liquidity as well as other considerations in the economy and markets.

The fund has a track record of generating above-average returns by prudently investing in sectors and issues of debt securities that have the potential to provide consistently superior yields at low levels of risk. It follows a diligent identification process for securities to pick the right debt and money market investment and that too, at the appropriate time.

Top portfolio holdings of Aditya Birla SL Banking & PSU Debt Fund

The securities quoted are for illustration only and are not recommendatory.
Holding in (%) as of August 31, 2023
(Source: ACE MF)

#4: Axis Banking & PSU Debt Fund

Launched a decade ago in June 2012 as a Banking debt fund, Axis Banking & PSU Debt Fund was initially launched with a mandate of investing predominantly in Banking debt instruments. However, in November 2016, the fund added an element of PSUs in its name and portfolio, making it one of the primary schemes with the Banking & PSU Debt mandate. The fund aims to generate stable returns at a lower credit risk while keeping the portfolio duration in check which helps it control interest rate risk as well. It focuses on instruments issued by high credit quality issuers and is usually invested in AAA-rated debt securities within the 3-year maturity bucket.

The investments in residual maturity bonds within this maturity help the fund take advantage of the accrual opportunities in this space. The fund manager has the flexibility to switch the portfolio duration depending on his views on the macroeconomic conditions, interest rate directions, systemic liquidity, and other factors.

Top portfolio holdings of Axis Banking & PSU Debt Fund

The securities quoted are for illustration only and are not recommendatory.
Holding in (%) as of August 31, 2023
(Source: ACE MF)

#5: ICICI Pru Banking & PSU Debt Fund

Launched in January 2010, ICICI Pru Banking & PSU Debt Fund invests predominantly in debt instruments with AAA credit rating profile. It also takes tactical allocation in government securities. The fund seeks to maintain moderate duration in 1 to 3 years range with limited active management. However, depending on market conditions and opportunities available, modified duration of the fund may go above 3 years. The fund also aims to generate accrual income by following hold till maturity approach for some portion of the portfolio.

ICICI Pru Banking & PSU Debt Fund follows partially buy-and-hold strategy which aims to generate optimum yield with decent credit quality portfolio. While selecting securities the fund undertakes rigorous in-depth credit evaluation to mitigate the risks. In addition, the investment team studies the macroeconomic conditions, including the political, economic environment and factors affecting liquidity and interest rates and accordingly positions the portfolio.

Top portfolio holdings of ICICI Banking & PSU Debt Fund

The securities quoted are for illustration only and are not recommendatory.
Holding in (%) as of August 31, 2023
(Source: ACE MF)

So there you go...a list of top five Banking & PSU Debt Funds to watch out for.

Remember that though Banking & PSU Debt Fund are relatively safer that cannot be considered risk-free. Therefore, before picking the best Banking & PSU Debt Fund for the portfolio investors must ensure that they understand the various risks involved and take an informed decision.

Disclaimer:

This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully.

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This article first published on PersonalFN here.