3 Best Banking & PSU Debt Funds for 2024

November 30, 2023 Mutual Fund

If you are looking at alternatives to invest in a bank Fixed Deposit or want to invest over and above, then debt mutual funds are a worthwhile choice.

However, among the sixteen sub-categories of debt mutual fund schemes, making the right decision is important. This is because every sub-category of a debt mutual scheme finds a distinct place on the risk-return spectrum depending on its specific investment mandate. In other words, not all debt funds are positioned the same on the risk-return spectrum. For this reason, when you approach debt funds, it is important to assess your personal risk profile and liquidity needs.

If you are looking for an alternative to invest in bank FD and have an investment time horizon of 2 to 3 years, then some of the best Banking & PSU Debt Funds may be a meaningful choice.

In this article, I’m going to elucidate which are the three best or top-performing Banking & PSU Debt Funds for 2024, but before that, let’s understand some basics.

What Are Banking & PSU Debt Funds?

Banking & PSU Debt Funds, a sub-category of debt mutual funds, predominantly invest in top-rated corporate debt instruments issued by Banks, Public Sector Undertaking (PSUs), Public Financial Institutions (PFIs), Municipal bonds, and other such securities. The regulatory guidelines make it mandatory to allocate a minimum of 80% of their assets into such debt instruments. The Debt instruments from these entities are recognised for their robust credibility and liquidity compared to those from private issuers, making them a relatively safer investment option.

As regards the maturity of debt papers, Banking & PSU Debt Funds have the flexibility to diversify their exposure across the yield curve. So, there isn’t any fixed limit for the portfolio duration.

Having said that, most Banking & PSU Debt Funds typically maintain durations ranging from 2 to 5 years. The decision is based on the evaluation of various micro and macroeconomic factors, including the interest rate cycle.

Banking & PSU Debt Funds, as a sub-category of debt funds, are moderately sensitive to interest rates. This means that it is susceptible to changes, especially in uncertain and rising interest rate environments.

However, in a rising interest rate environment, they potentially benefit from regular coupon payouts on bonds and may use a partial accrual strategy to mitigate volatility during rising interest rate periods.

What Is the Investment Objective of Banking & PSU Debt Funds?

Broadly, the primary investment objective of Banking & PSU Debt Funds is to generate reasonable returns broadly in line with the aforesaid debt and money market securities, such as Scheduled Commercial Banks (SCBs), PSUs, PFIs, bonds issued by Municipal Corporations and such other bodies, by maintaining optimal balance of yield, safety, and liquidity.

However, there is no assurance that the investment objective will be realised.

Are Banking & PSU Debt Funds Safe?

Given that the underlying investment is in market-linked debt & money market instruments, investment in Banking & PSU Debt Funds cannot construed as safe or risk-free (like in the case of an FD with a robust bank).

Graph: Risk-Return Spectrum Debt Mutual Funds

For illustration purposes only
(Source: PersonalFN Research) 

Banking & PSU Debt Funds do carry some level of interest rate and credit risk. So, a lot depends on the portfolio characteristics of the scheme you decide to add to your portfolio.

Is It an Opportune Time to Invest in Banking & PSU Debt Funds?

Well, at present, the Reserve Bank of India (RBI) seem hawkish given the inflation risk. The finance ministry recently admitted that inflation is still a risk, and the government and the RBI are on high alert for it. The central bank is particularly worried about the rise in food prices. Considering this, policy rates have been kept elevated.

Although the margin of safety has increased after 250 basis points (bps) almost absorbed in the economy, as an investor, you need to be cautious and conscious of the underlying debt papers held by the schemes. Prefer safely managed ones that carry low credit risk and interest rate risk, as opposed to those engaging in yield hunting.

If you choose among the best Banking & PSU Debt Funds with worthy portfolio characteristics, i.e., high-quality debt papers and suitable duration (of around 2 to 5 years), it could offer stability and potentially earn you decent market-linked returns.

The category average returns over 1 year, 2 years, and 3 years are 6.70% absolute, 5.06% CAGR, and 4.8% CAGR, respectively, as of November 27, 2023.

How to Make the Best Choice of Banking & PSU Debt Funds for 2024?

To make the best choice from a plethora of schemes available, you need to evaluate a host of quantitative and qualitative parameters, such as the following:

• The AUM and expense ratio of the scheme
• The credentials and experience of the fund management team
• The portfolio characteristics (who are the issuers, the sector they belong to, the type of debt papers held, the ratings of the respective debt papers, etc.)
• The maturity profile of the fund (the average maturity, Yield-To-Maturity (YTM), and the Modified Duration (MD) of the portfolio)
• Returns across time periods (3 months, 6 months, 1 year, 2 years, 3 years, and so on)
• The risk ratios (Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.)
• The performance across interest rate cycles

Also, it would be better to understand the investment ideologies, processes, and systems.

If the mutual fund house lacks a robust risk management framework and depends excessively on ratings assigned by credit rating agencies, the fund manager compromises on the quality of the portfolio, chases yields, and plays down on the liquidity aspects of the portfolio, then as an investor, you should be concerned.

Which Are the Best Banking & PSU Debt Funds for 2024?

Considering the aforementioned parameters to make the best choice, the three Best Banking & PSU Debt Funds for 2024 are:

1) ICICI Prudential Banking & PSU Debt Fund

2) Bandhan Banking & PSU Debt Fund

3) HDFC Banking & PSU Debt Fund

These schemes are holding quality debt papers of banks, PSUs, and PFIs plus with a maturity profile of around 2 to 4 years.

Table 1: 3 Best Banking & PSU Debt Funds for 2024

Performance as of November 27, 2023. Returns are point-to-point and in %, calculated using the Direct Plan-Growth option.
Standard Deviation indicates Total Risk and Sharpe Ratio measures the Risk-Adjusted Return. The Sortino Ratio indicates the ability of the schemes to limit the downside risk, as it considers the downside deviation.
All ratios are calculated over a 2-year period assuming a risk-free rate of 5% p.a.
Past performance is not an indicator of future returns.
*Please note, this table only represents the best-performing schemes based solely on past returns and is NOT recommendations as such.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, PersonalFN Research) 

Here are some other details why these schemes are best in the Banking & PSU Debt Funds category…

Best Banking & PSU Debt Fund for 2024 #1: ICICI Prudential Banking & PSU Debt Fund

Launched in January 2010, the primary investment objective of ICICI Prudential Banking & PSU Debt Fund is to generate income through predominantly investing in Debt instruments of banks, PSU, PFIs, and Municipal Bonds while maintaining the optimum balance of yield, safety and liquidity.

In this endeavour, the fund predominantly invests in AAA-rated debt papers (comprising of corporate debt instruments and Certificate of Deposits of credible issuers) and holds cash-and-cash equivalents.

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 and economic environment as well as the other factors affecting liquidity and interest rates and accordingly positions the portfolio. It holds a fairly diversified portfolio across maturity papers.

Table 2: Top-10 Holdings of ICICI Prudential Banking & PSU Debt

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

As per its portfolio as of October 2023, it has held 74 debt securities. In the past month, it added an Alternative Investment Fund (AIF), namely the Corporate Debt Market Development Fund, which currently comprises 0.2% of its portfolio.

It has maintained an average maturity of over 4 years, higher than its category average. Weighted average maturity refers to the maturity of all the underlying securities held by the fund.

ICICI Prudential Banking & PSU Debt seeks to maintain a moderate duration in the 1 to 3-year range with limited active management. However, depending on market conditions and opportunities available, the modified duration of the fund may go above 3 years.

ICICI Pru Banking & PSU Debt Fund has respectable portfolio traits and follows a partially buy-and-hold strategy which aims to generate optimum yield. The fund currently has a Yield-to-Maturity (YTM) of 7.7%, but this may vary as the fund manager buys and sells debt securities in the portfolio.

ICICI Prudential Banking & PSU Debt is managed by Ms Chandini Gupta and Mr Rohit Lakhotia.

Ms Gupta has been designated the fund manager of the fund since April 2017 and holds over 15 years of experience in the investment management sphere. She holds a B.E. in IT and is a CFA Charterholder.

Mr Lakhotia has been co-managing this fund since June 2023. Before joining ICICI Prudential Mutual Fund, he worked with Yes Bank in the Corporate Banking Group.

Best Banking & PSU Debt Fund for 2024 #2: Bandhan Banking & PSU Debt Fund

Bandhan Banking & PSU Debt Fund, erstwhile known as IDFC Banking & PSU Debt Fund, was launched in March 2013 before the takeover of IDFC AMC by Bandhan AMC. The scheme aims to maximise returns through investments in top-rated money market and debt securities issued by Banks, Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), and Municipal Bonds.

To achieve its investment objective, Bandhan Banking & PSU Debt Fund mainly invests in AAA-rated corporate debt papers (of reputed banks, housing finance companies, power finance companies, and PSU players), government securities, and holds cash-and-cash equivalents.

For portfolio construction, the fund assesses inflation, interest rate cycles, overall liquidity, and other macroeconomic dynamics.

Table 3: Top-10 Holdings of Bandhan Banking & PSU Debt Fund

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

Currently, as per the October 2023 portfolio, Bandhan Banking & PSU Debt Fund has around 80 debt securities. In the past month, the fund has added an Alternative Investment Fund (AIF), specifically the Corporate Debt Market Development Fund, which currently comprises 0.2% of its portfolio. Similarly, it has added commercial paper [of Export-Import Bank of India -364D (15-Mar-24)] comprising 0.3% of the portfolio.

The average maturity profile is around 2.5 years, while the fund mainly 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. This enables the fund to leverage on the accrual opportunities.

With a portfolio diversified across short to medium-term instruments, Bandhan Banking & PSU Debt Fund’s performance is closely linked to the yields prevailing at the shorter end of the maturity curve and the quality of instruments in the portfolio. The accrual strategy followed by the fund could help reduce the impact of interest rate risk during a rising interest rate scenario.

The current YTM of the fund is 7.7%, but this could change as the fund manager buys and sells debt securities in the portfolio.

Bandhan Banking & PSU Debt Fund is one of the top quartile performers, consistently delivering satisfactory returns to its investors across various timeframes. On the risk-adjusted return, the fund has fared well by adhering to a well-rounded risk management strategy aimed at effectively mitigating the risks associated with debt market investments.

Bandhan Banking & PSU Debt Fund is managed by Mr Suyash Choudhary and Mr Gautum Kaul.

Mr Choudhary is the Head of Fixed Income at Bandhan Mutual Fund. He has two decades of experience in Fixed Income. Prior to joining Bandhan AMC, Mr Choudhary was associated with HSBC Mutual Fund as Head – Fund Management (Fixed Income), and before that was associated with Bandhan AMC in its earlier avatar, Standard Chartered AMC, as a Fund Manager. He holds a PGDM from IIM-Calcutta and a BA (Hons) degree in Economics from the University of Delhi. He has been managing Bandhan Banking & PSU Debt Fund since July 2021.

Mr Kaul is a Senior Fund Manager – Fixed Income at Bandhan Mutual Fund. He has been co-managing Bandhan Banking & PSU Debt Fund since December 2021. He was earlier associated with Edelweiss AMC as a fund manager and before that with IDBI AMC, Religare AMC, Sahara AMC and Mata Securities. He holds an MBA (Finance) and a B.Com (Hons) degree.

Best Banking & PSU Debt Fund for 2024 #3: HDFC Banking & PSU Debt Fund

Launched in March 2014, HDFC Banking & PSU Debt Fund focuses on high-quality debt instruments issued by Banks, PSUs, PFIs, and Municipal Bonds. A dominant portion of its assets are AAA-rated corporate debt papers, CDs, government securities, and it holds cash-and-cash equivalents while aiming to achieve its investment objective. In the past month, the fund also added, much like its peers, an AIF, namely the Corporate Debt Market Development Fund.

HDFC Banking & PSU Debt Fund enjoys the flexibility to modify the portfolio’s duration as per their judgment and expectations regarding interest rate shifts, current liquidity situations, and other macroeconomic elements.

Table 4: Top-10 Holdings of HDFC Banking & PSU Debt Fund

Data as of October 31, 2023
(Source: ACE MF, PersonalFN Research) 

Currently, as per the October 2023 portfolio, HDFC Banking & PSU Debt Fund has 77 debt securities. The fund makes good use of diversification to mitigate credit risk by spreading its portfolio across high-rated instruments issued by entities across public and private segments.

HDFC Banking & PSU Debt Fund holds a portfolio with a duration of approximately 2 to 3 years, indicating a moderate sensitivity to shifts in interest rates and, consequently, exposing investors to a moderate level of interest rate risk. The current average maturity is around 3.5 years.

The investments in residual maturity bonds within shorter maturity buckets help the fund take advantage of the accrual opportunities in this space. It potentially reduces the adverse impact on valuation during periods of rising interest rates and helps it perform well compared to its peers that have higher portfolio duration.

The current YTM of the HDFC Banking & PSU Debt Fund is 7.7%, but this could change as the fund manager buys and sells debt securities in the portfolio.

HDFC Banking & PSU Debt Fund has exhibited commendable performance, consistently meeting investor expectations by rewarding them with stable returns while maintaining a moderate level of credit risk and moderately high exposure to interest rate fluctuations. It has displayed a track record of delivering adequate returns vis-a-vis the risk. Thus, the fund finds its place in the top quartile.

HDFC Banking & PSU Debt Fund has been managed by Mr Anil Bamboli since its inception.

Mr Bamboli is a Senior Fund Manager – Debt at HDFC Mutual Fund. He has a collective experience of over 28 years in Fund Management, Research, and Fixed Income dealing. Before joining HDFC AMC in July 2003, Mr Bamboli worked as Asst. Vice President at SBI Funds Management. Mr Bamboli holds an MMS (Finance) degree, Grad CWA, and is a CFA Charterholder.

Overall, these three Banking & PSU Debt Funds are from fund houses that follow robust investment processes and systems.

Who Should Invest in the Best Banking & PSU Debt Funds?

Banking & PSU Debt Funds are meant for investors with a moderate-risk appetite, if you want to have exposure to banking & PSU debt securities and for an investment time horizon of around 2 to 3 years. Note, that some degree of credit risk and interest rate risk is expected when investing in Banking & PSU Debt Funds.

What Are the Tax Implications of Investing in Banking & PSU Debt Funds?

For all debt funds, with effect from April 1, 2023, the capital gain arising at the time of redemption — whether short-term (a holding period of less than 36 months) or long-term (a holding period of 36 months and above) — is also taxed as per investors’ tax slab. 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.

[Read: Debt Mutual Funds are Now at Par with Fixed Deposits for Taxation]

For NRIs, the capital gains on debt-oriented mutual funds are subject to Tax Deduction at Source (TDS) at the rate of 10% for LTCG and 30% for STCG.

If you have opted for the dividend option (now known as IDCW option), for resident Indians, any dividends from Banking & PSU Debt Funds (under the Dividend Option) are added to the investors’ total income and are taxed according to your income-tax slab, i.e., at the marginal rate of taxation. However, if the dividend amount is more than Rs 5,000, Tax Deduction at Source (TDS) will be first done at the rate of 10%. For NRIs, the dividend received is taxed at the rate of 20%.

To sum-up…

Make an informed decision when you invest in Banking & PSU Debt Funds – or any mutual fund for that matter. Don’t just base your investment decision on past returns or mutual star ratings given on historical performance, but also pay close attention to the portfolio characteristics of the funds.

Be a thoughtful investor; deploy your hard-earned money sensibly. When in doubt, speak to a SEBI-registered investment advisor.

Happy Investing!

This article first appeared on PersonalFN here