Readers' Corner: Mutual Funds

Nimesh Shah, managing director & chief executive officer, ICICI Prudential Asset Management Company, answers your questions

I want to invest in debt funds now, as banks are reducing the fixed deposit rates. What should one keep in mind? How are returns calculated?

While investing in debt funds, it is important to consider one's investment objective, horizon and risk appetite. For a short-term investment horizon of less than six months, invest in ultra short-term funds and liquid funds, with an objective of parking surplus funds and limiting risks. For a medium-term horizon of one year and more, accrual funds could be a suitable investment. For longer term horizon of three years and above, look at duration funds. Returns for some funds are calculated on the basis of accrual income, while in other cases, the returns are calculated on the basis of both accrual income and capitals gains. These returns are factored in one's net asset value (NAV) per unit.

I have sold my house in the village and will be using that money to make down payment for my flat in Mumbai. I want to keep the money in a debt fund for two months before making the payment for the house. Is there a debt fund that will help me avoid paying tax on the interest I earn?

Since the horizon of investment is short-term, it makes sense to invest in a debt fund with high liquidity and low risk, such as liquid funds. Liquid funds are open-ended debt mutual fund schemes, which help manage short-term cash surpluses with an endeavour to provide optimal returns commensurate with low risk and a high degree of liquidity from a portfolio constituted of money market securities and short-term debt securities. Debt funds enjoy indexation benefit if one stays invested for three years, which in your case is not possible, considering the purpose and horizon of investment.

Since both balanced funds and arbitrage funds invest in stocks and bonds, what is the difference between the two?

Balanced funds invest in both equity and debt in a proportionate manner (usually 65 per cent in equity and 35 per cent in debt) to offer the dynamism of equities and the relative stability of debt. Arbitrage funds seek to take advantage of the price difference between the cash and derivative segments of equity markets as well as the price difference between opportunities available within the derivative segment, while allocating the balance portion in debt and money market instruments.

While arbitrage funds offer stable risk-free returns, balanced funds offer an opportunity to participate in the growth of equities.

The views expressed are expert's own. Send your queries to yourmoney@bsmail.in