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Debt funds mainly use 2 strategies to ensure higher returns. One is duration strategy and the other is accrual strategy. A debt fund that uses the accrual strategy is called an accrual fund. In this article, we will cover everything you need to know about accrual funds.
Accrual funds are a type of debt mutual funds. This means they are low risk investments, and typically invest in short to medium maturity plans. They take credit risk and invest in lower-rated securities for the sake of generating a higher yield. The main aim of accrual funds is to earn interest income in terms of coupon offered by bonds. These funds adopt buy and hold strategy and, and hold the assets till maturity. They also focus on generating better returns compared to bank FDs.
It all depends on your risk profile and financial objective. For instance, accrual debt fund is less volatile than duration-based debt fund. Accrual fund strategy is relatively more predictable in returns. So a conservative investor with a low-risk appetite can opt for this.
As they offer more stability, accrual funds are more relevant for long-term investments. There will be no need to review or evaluate these funds across market cycles and interest fluctuations. Yet, it all depends on how the fund manager takes a call. It will be better for first-time investors to treat these funds, therefore as a topping rather than an integral part of the portfolio.
Accrual debt funds do not take risks when it comes to interest rates. They only invest in small to midterm tenured bonds.
Accrual funds undertake credit risk by purchasing companies with a weaker credit rating, but more robust business prospects. They do this in the hope of company doing well and improving the credit score in thee immediate future.
Accrual funds put their money in companies for the long duration. This way, investors can capitalize on interest income that they generate.
Like most debt funds, accrual funds too are more tax-friendly compared to FDs. This is because they are taxable at the slab rate of 20%, while FD is taxed at 30%. So, investors in the highest tax bracket need to pay only 20% tax on the returns. There is also the benefit of indexation on the returns.
As we know that accrual funds follow a buy and hold strategy, the fund household on to the securities until their maturity. Let’s discuss the primary two categories of accrual funds
Credit opportunity funds are debt mutual funds that adopt the accrual strategy to provide better returns. They take credit risk to generate high yield. Usually, this type of accrual fund works on the basis of mismatch in the bond rating and the company fundamentals. Therefore, if the company’s fundamentals improve, the bonds too may experience a boost. However, credit opportunity funds do involve greater risk than corporate bond funds as these invest in lower rated papers.
Contrary to credit opportunity funds, corporate bond funds are lower risk accrual funds. Hence, they do not base their function on mismatches and invest only in higher quality papers. Unlike credit opportunity funds, these do not involve in taking any extra credit risks. Financial planners recommend this at the end of the rate cut cycle, or when they expect a rate cut. This is because these funds are less volatile, making the capital depreciation lower.
In short, if you are not a risk seeker, an accrual fund can serve your purpose. It is also easier to manage and you don’t have to watch the market all the time. However, if you wish for a little more equity exposure, there are hand-picked funds from the top fund houses in India to select from ClearTax Save. So choose accordingly and start investing.