Top 10 Income Funds

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Income funds belong to the category of debt funds as they predominantly invest in government bonds/securities and money market instruments like a certificate of deposit. It is an excellent option for investors who seek a steady income. In this article, we have covered the following topics, as well as talk about the top 10 income funds in India.

1. Income Funds

Income funds are debt mutual funds or ETFs that invest in corporate bonds, government bonds and money market instruments. The portfolio is managed based on interest rates movements keeping in mind the creditworthiness. They are investment graded with credit quality, assuring capital preservation. It prioritises assets with higher interest rates. This generates a high dividend that is either invested or distributed to the investors.

2. Who Should Invest in Income Funds

Income funds mainly invest in government bonds, corporate bonds, Certificate of deposits, and money market instruments. They result in generating interest income by holding the investment until maturity or make gains by selling them in the debt market if the returns on the investment are comparatively better. Changes in interest rates impact the fund considerably. Hence, it is most suited for investors who are willing to take risk aggressively and as well as those looking to invest with a long-term horizon. Therefore, it is vital to plan and time your entry and exit from these funds judiciously, for the same reason. These funds focus on generating income for the investors rather than wealth creation. As such, they are a great source of financial gain for investors looking for regular and reliable income.

3. Factors to Consider Before Investing in Income Funds

a. Risks

The risk aspect of income funds depends on the type of holdings. If the equity component is more, then risk will also be more. Equities and bond prices have a negative correlation. Income funds invest in both stock and bond markets and provide for a hedge against market risks. Income funds carry interest rate risk and credit risk.

b. Returns

Income funds deliver the benefits of compounded interest if the investment horizon exceeds one year. This has been the trend for the last 10 years.

c. Tax-Efficiency

If you are in the 20% and 30% tax slab, then you should know that income funds held for more than three years are subject to long-term capital gains (LTCG) tax. It is taxable at the rate of 20% with indexation benefit. However, income funds provide increased returns after taxation to investors in the 30% tax slab.

d. Investment Horizon

There are some short-term income funds with an investment horizon of just a few days. Here, investors may want a safe place to park their money for a short period. Medium to long-term debt funds, on the other hand, have a longer investment horizon.

e. Cost of the Fund

The best time to invest in income funds is when there is going to be a fall in interest rates since they make money by either holding the instruments until maturity or by selling them at the right time, in the debt market if the returns are positive.

4. How to Evaluate Income Funds

The following parameters can be used to evaluate income funds:

a. Fund House Reputation

While the asset management company faces many risks, nothing could be more significant than the loss of reputation. This is because a first-time investor almost always stumbles to mutual fund investment through word of mouth.

b. Fund History

There is a temptation to choose that fund that has delivered excellent returns in the past. However, it is essential to consider how long the fund has been in operation and how it has fared across market cycles.

c. Past Returns

An income fund that has performed well in the previous year may emulate the good returns only if the market conditions remain favourable. However, you can assess the fund manager’s skills based on past performances and how well he/she has coped with volatility.

d. Financial Ratios

There are several risk assessment tools to track and evaluate the performance of income funds. Nowadays, investors can easily find this information on mutual fund websites as well as third-party sites. Some of them are listed below: i. Expense Ratio: The investors must consider the expense ratio of the fund (fee to the fund house) when they look at the overall cost and returns. They deduct this fee from the returns your investment generates, though not more than 2.5% of the NAV as per the SEBI rules. ii. Information Ratio: It is an indicator of the fund manager’s expertise and skill to deliver risk-adjusted returns above the benchmark. Information ratio is nothing, but the benchmark return deducted from the overall portfolio return. iii. Sharpe Ratio:Higher returns on paper don’t always indicate better performance. You can only assess an income fund’s performance when you judge the gains in line with the risk involved. So, a higher Sharpe ratio indicates better return/performance against the risk per unit the fund undertakes. You can only use this tool to compare different mutual funds. iv. Standard Deviation: As the term suggests, the standard deviation shows how much the fund returns have deviated from the average returns. For example, if the average return is 12% and the fund delivers 15%, then there is a positive deviation.

5. Top 10 Income Funds

Income funds are designed to generate income from interest on investments. It could be small to medium-term bonds with a maturity period of one year to three years, or three years to five years that offer a steady annualised returns, which make this fund less volatile in nature. Therefore, investors must adjust and match their investment timeline with the maturity of these funds. Following is the list of best income funds for short-term investors (1 year):

Fund Name 1 Year Return
Nippon India Gilt Securities Fund- GrowthGilt Fund 14.95%
Nippon India Income Fund – GrowthMedium to Long Duration Fund 13.85%
Edelweiss Government Securities Fund – Regular Plan – GrowthGilt Fund 13.71%
SBI Dynamic Bond Fund – GrowthDynamic Bond Fund 13.70%
Edelweiss Banking and PSU Debt Fund – Regular Plan – GrowthBanking and PSU Fund 13.41%
IDFC Dynamic Bond Fund – Regular Plan – GrowthDynamic Bond Fund 13.20%
PGIM India Dynamic Bond Fund – GrowthDynamic Bond Fund 13.02%
DSP Corporate Bond Fund – Regular Plan – GrowthCorporate Bond Fund 12.79%
LIC MF Banking & PSU Debt – GrowthBanking and PSU Fund 11.36%
IDFC Bond Fund – Medium Term Plan – Regular Plan – GrowthMedium Duration Fund 10.82%
The above income funds are chosen based on their previous years’ returns. Therefore, it also proves that they are a good steady source of financial income for investors looking for current income generation as opposed to a long-term gain.