Exploring the relative stability in banking and PSU funds

Banking and Public Sector Undertaking (PSU) funds are debt mutual funds that invest primarily in instruments issued by banks, PSUs, and public financial institutions. These funds aim to provide relative stability and regular income potential for conservative investors by investing in high credit quality issuers.

However, banking and PSU funds do face risks like interest rate volatility, liquidity issues and credit downturns that can potentially impact their stability.

• Table of contents

1. Understanding banking & PSU funds
2. Factors affecting stability in banking and PSU funds
3. Challenges to stability in banking and PSU funds
4. Strategies for maintaining stability in banking and PSU funds

Understanding banking & PSU funds

Banking & PSU debt funds are a type of debt mutual fund that invests at least 80% of assets in debt instruments of banks, public sector undertakings, public financial institutions, and municipal bonds. They aim to provide liquidity and stability with relatively low risk and volatility compared to equity-oriented funds.

Banking and PSU fund managers target high quality debt instruments to minimise default risk. Hence, these funds may be suitable for short-term investors seeking a higher return potential than traditional bank deposits with slightly higher relative risk.

Factors affecting stability in banking and PSU funds

• Credit quality - Funds that invest in high credit quality debt instruments of banks, PSUs, PFIs and municipal bonds have a relatively lower risk of default. This enhances relative stability.
• Government backing - Instruments issued by PSUs and PFIs often have an implicit government guarantee which reduces credit risk. Sovereign instruments also have minimal default risk.
• Portfolio maturity - Funds that maintain a portfolio of short to medium-term securities provide better liquidity and relative stability versus those with longer maturity bonds.
• Interest rate environment – A rising interest rate environment may cause a fall in bond prices and impact performance, thus reducing stability.
• Regulations - SEBI regulations on minimum credit ratings, issuer limits etc. also enhance portfolio stability.

Challenges to stability in banking and PSU funds

The key challenges to stability in banking and PSU debt funds include the following mentioned below.

• Deterioration in credit quality - Any downgrade in the credit rating of securities held can increase credit risk and reduce stability. Problems in the banking sector can spill over to PSUs.
• Interest rate volatility - Sharp movements in interest rates especially rising rates can lead to devaluation of bond portfolios, impacting stability.
• Liquidity risks - In certain market conditions, lower secondary market liquidity for bonds can make it difficult for funds to meet redemptions.
• Sector concentration - Portfolio concentration in banking and PSU securities increases sector-specific risks relative to diversified funds.
• Macroeconomic risks - A slowdown in growth and business uncertainties can strain the cash flows of issuers. This can increase default risks.

Strategies for maintaining stability in banking and PSU funds

Banking and PSU fund strategies like limiting the duration and investing in high credit quality instruments are important for relative stability in volatile rate environments. Banking and PSU fund strategies for stability emphasise credit evaluation, liquidity management and active duration management to minimise risks.

• Invest in high credit quality securities of banks and PSUs as mandated by regulations. This reduces credit risk.
• Manage interest rate risk through measures like maintaining a portfolio of securities with varied maturities and limiting duration.
• Ensure adequate portfolio liquidity to meet redemptions by investing in liquid money markets and short-term securities. Maintaining some allocation to liquid government securities also helps.
• Limit exposure to individual issuers and groups to contain concentration risk and sectoral risks.
• Rigorously monitor the portfolio credit quality, watch for rating downgrades, and make timely changes to preserve credit quality.
• Follow a disciplined investment approach within regulatory limits to balance risk-return.

Conclusion

Through robust credit evaluation, liquidity management and active duration management, fund managers work to maintain the stability of the portfolio of banking and PSU funds. For risk-averse investors with medium to long-term goals, banking and PSU funds can be a suitable component in an overall diversified investment portfolio, providing relative stability and a steady return potential. Following prudent banking and PSU fund tips for stability such as avoiding concentration risks and maintaining liquidity is key to steady returns potential. You can consider investing in banking and PSU fund of Bajaj Finserv Banking and PSU Fund for potentially stable returns from the debt segment.

FAQs:

What is the significance of stability in banking and PSU funds?

Stability in banking and PSU funds provides investors relative steady returns, making these suitable options for conservative investors seeking lower-risk debt investments.

How do economic conditions impact the stability of financial institutions?

Unfavourable economic conditions like high inflation, low growth, and tight liquidity can adversely impact the stability of banks and PSUs by increasing defaults, eroding profits, and creating capital shortfalls.

What is the difference between banking and PSU funds and other debt funds?

Banking and PSU funds primarily invest in debt instruments issued by banks and public sector undertakings, which are considered relatively stable. In contrast, other debt funds may invest in a broader range of debt securities, including corporate bonds with varying credit ratings, making them comparatively riskier.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.