Banking & PSU Funds- Definition, Benefits, Risks and Taxation

Banking & PSU Funds are open-ended debt funds predominantly investing in debt instruments of banks, Public Sector Undertakings (PSUs) and Public Financial Institutions as classified by SEBI.

What are Banking & PSU Funds

Earlier known as short-term funds or income funds, SEBI introduced this category of funds a couple of years ago. Here’s more that you should know about Banking & PSU funds-

• As the name suggests, Banking & PSU Funds are mutual funds investing about 80% of their corpus in debentures, bonds, and certificates of deposit of banks and PSUs
• These funds usually invest in debt securities that have high liquidity and low average maturity
• Risk averse investors looking for higher returns than Bank Fixed Deposits (FDs) can go for Banking & PSU Funds as these mostly invest in AAA-rated or equivalent categories that boast of high credit ratings and enjoy quasi-sovereign status as borrowers
• Moreover, Government ownership in these funds assures repayment. Banking & PSU funds have a low-risk profile of an ultra short-term debt fund and the return potential of an income fund
• Investments in these funds are ideal for seasoned investors looking for a steady credit profile with less volatility

Who should Invest

• Being a type of debt funds, these funds are not highly market volatile and hence, are suitable for conservative investors with low risk appetite
• Investors looking for an option to bank deposits that generate higher returns (also carries a slightly higher risk than FDs) should consider investing in these funds
• Investors wanting to invest in debentures of high credit quality and liquidity are ideal for these funds
• Short term to medium term investors can invest in these funds as the average maturity period of Banks & PSU Funds is 1-2 years

Advantages of Banking & PSU Funds

• High Liquidity

These funds invest in top-rated instruments (hold PSU bonds such as that of NABARD, SIDBI, etc.) and thereby Banking and PSU Fund schemes are highly liquid. It can generate stable fund returns as PSU bonds are well traded and fund managers can gain from capital appreciation opportunities when rates fall. This is an additional benefit for the investors who seek returns in the time-frame of 1-2 years.

• Low Risks

Banking and PSU Funds carry a low risk of market volatility as it invests in high credit quality funds, for short/medium-term investments. It is not completely risk-free but carries a lower risk than many other debt funds like Dynamic Bond Funds or Credit Risk Funds.

• Better Returns

Banking & PSU funds are a good alternative to Fixed Deposits, if one wants slightly higher returns than FDs in short tenure and can take little risks. These have often been viewed as safe havens amid debt crisis because of better price discovery. However, many experts suggest that liquid funds are the best alternative to FDs.

Risks Involved

Although Banking and PSU Bonds are considered to be less risky, these do face risks from the interest rate movement. These funds might also perform poorly in case of hardening or flat interest rates. These may show negative returns when yields go up

as all bonds/debentures are traded and mark-to-market losses are inevitable. However, these funds have not shown negative returns over the time frame of 3 months or longer. As these funds are quite newly included, not much track record is available to look at for the performance. The annual returns have been around 8.6%-8.9%, which is way higher than traditional debt options.

Things to be considered before investing

Every investment requires a sufficient amount of research and valuation of factors such as risks involved, history of returns accrued, business proficiency of the holdings, etc. Here are some of the things which must be considered by an investor before investing in mutual funds:

1. Financial Goal– Before making any investment decisions, it is very important to evaluate that the fund objective is aligned to your financial goals 
2. Fund Performance– Measuring the performance of the fund in both bullish and bearish market situations is a necessity as it helps the investors in selecting a reliable fund. One should always choose a fund which has been performing with consistency
3. Fund House & Management– There are numerous mutual funds regulated by different AMCs (Asset Management Companies). Fund houses & fund managers play a very decisive role in the allocation of assets and the selection of stocks. If the management has enough experience and expertise, the fund will easily sail through promising market conditions and deliver good returns
4. Costs Involved– There are different costs involved in mutual fund investments such as expense ratio, entry load, and exit load. Investors must review these costs before heading up for investments
5. Other Basics from the Portfolio: There are multiple other factors such as the fund NAV (Net Asset Value), AUM (Assets under Management), etc. which are to be considered before investing to ensure the reliability and investor engagement in the fund

Top 10 Banking & PSU Funds to Invest in 2020

Fund’s Name	3 Year Returns (%)	5 Year Returns (%)
Edelweiss Banking & PSU Fund	9.73	8.99
Franklin Banking & PSU Debt Fund	9.54	8.94
Axis Banking & PSU Debt Fund Direct	8.88	8.68
Kotak Banking & PSU Fund Direct	8.83	8.90
SBI Banking & PSU Debt Fund	8.81	8.83
ABSL Banking & PSU Debt Fund	8.71	8.99
Nippon India Banking & PSU Debt Fund	8.70	–
IDFC Banking & PSU Debt Fund	8.68	8.44
PGIM Banking & PSU Debt Fund	8.63	8.61
LIC Banking & PSU Debt Fund	8.61	8.24

Taxation

Banking & PSU Funds are taxed as per the taxation norms of Debt Fund plans and if profits are held for more than 3 years then it is considered as long term capital gains that attract a tax of 20% with indexation benefit. If an investor has made a capital gain of ₹50,000 on investment in a debt mutual fund and withdraws the amount before 3 years of investment, Short Term Capital Gains Tax would be levied, as per the income tax slab of the investor. ₹50,000 would be added to the taxable income of the investor and taxed accordingly. 

If an investor withdraws the investment including capital gains post 3 years of investment, 20% Long Term Capital Gains Tax of 20% is levied, with the benefit of indexation. 

Indexation reduces the value of overall Long Term Capital gains to reflect the effect of inflation on your investment. 

To calculate the final value of capital gains post indexation, we use the government’s Cost Inflation Index (CII) in the following formula:

Indexed cost of Acquisition = Investment Amount * (CII of the year of withdrawal/ CII of the year of investment)

Suppose the investment amount is ₹70,000 in the year 2016 and the withdrawal amount is ₹1 Lakh. The value of capital gains is ₹30,000 before indexation 

Indexed Cost of Acquisition= 70000* (280/254) = 77165.35

Note: CII in the year 2015 = 254

          CII in the year 2018 = 280

Final Value of Capital Gains= 100000- 77165.35 = 22834.65

Tax Payable = 20% of 22834.65 = 4566.93

How to Invest in Banking & PSU Funds

You can invest in Banking & PSU funds through either of the following ways-

• Offline mode of investing– If you are not confident of your knowledge, you may choose to invest through a broker. However, investing in a fund through a broker will make you eligible for investments through regular plans that offer different returns and varied expenses in investment. If you wish to invest in the fund independently, you must visit the nearest branch of the AMC of your fund. Don’t forget to carry the following documents-
  • Identity Proof (Aadhar Card)
  • Canceled cheque
  • Passport size photos (around 4-5)
  • PAN Card
  • KYC documents (for KYC verification)
• Online mode of investing– If you do not wish to add on to your expense of commissions or brokerage, you may visit online investment platforms such as Paisabazaar.com wherein you can choose from and compare more than 1,700 funds- all in one place, instead of following the long procedure of visiting the website of each AMC and then choosing from them. Here, you can select the fund in which you want to invest, look at the details and compare similar schemes as well as use SIP Calculator or Lumpsum Calculator to estimate the future value of your investment

For detailed information on how to invest in mutual funds, click here