Can Low-Risk MF Investments Give High Returns?

Introduction To Low-Risk Mutual Fund Investments

In India, there are different mutual funds to invest in, depending on your financial goals and risk appetite. When it comes to building wealth, most investors think of high-risk investments because of their high return potential. However, the belief that “high risk = high returns” is not always true. While risky investments such as equity can deliver substantial gains over time, they can also lead to equally large losses during volatile markets. 

This is where a low-risk mutual fund comes into the picture. Such a fund primarily invests in debt instruments and offers stable returns and steady growth, without exposing investors’ money to excessive fluctuations. But is there such a thing as low-risk, high-return mutual funds? We’ll find out in this article. 

Why “High Risk = High Returns” Is a Myth

It is a common belief that if an investment carries high risk or is highly volatile, it will automatically generate high returns. However, many investors overlook the fact that while the potential for higher returns exists, there is no guarantee of achieving them. 

High-risk investments like equity are often said to be volatile only in the short term, which leads people to assume that long-term returns are assured. But this is not always true. Equity funds can also significantly underperform and even erode wealth during prolonged bear phases. In contrast, low-risk mutual funds may deliver modest but consistent returns. In some instances, they can even outperform equity. 

How Low-Risk Mutual Funds Can Outperform Expectations

While low-risk mutual funds may not consistently outperform equities over the long term, they can deliver better returns in certain situations, particularly when compared to Fixed Deposits (FDs) or even equities in the short run. Here’s how: 

1. Focus on securities with strong fundamentals and high credit ratings

These funds invest in top-rated debt instruments such as AAA-rated bonds, treasury bills, and government securities. High credit rating, coupled with strong fundamentals, minimises default risk and offers stability during volatile times, sometimes even outpacing equity returns. 

b) Tax Efficiency via Indexation

2. Benefits of passive funds

Passive funds, such as debt index funds or target maturity funds, simply track a benchmark and do not engage in active trading. As a result, they come with lower expense ratios. Lower costs can translate to higher net returns for investors. Many also see target maturity funds as a potential alternative to FDs, as they offer relatively predictable returns with the possibility of outperforming traditional deposits. 

Note: This benefit is only available to debt fund units bought before April 1, 2023. All gains from debt fund units bought from April 1, 2023 onwards will be taxed as short-term capital gains at your slab rate.

3. Low volatility and conservative approach

Debt funds are generally less volatile than equity funds. During market downturns, they can offer better risk-adjusted returns, i.e., returns relative to the risk taken. Such funds are better suited for conservative investors with a low risk appetite, who prioritise investment safety over high growth. 

Types Of Low-Risk Mutual Funds To Consider

Mutual funds are broadly classified into three categories: equity, debt, and hybrid. Of these, debt funds are generally considered the least risky. Here are some debt fund options to consider: 

1. Overnight funds: These invest in securities that mature in one day. The ultra-short maturity period almost eliminates interest rate risk and credit risk. With no exit load, they are also highly liquid. 
2. Liquid funds: These invest in securities with a residual maturity of up to 91 days, such as treasury bills, commercial papers, and Certificate of Deposits (CDs). 
3. Ultra short duration fund: These invest in debt and money market instruments such that the Macaulay Duration of the fund is between 6 months and 12 months. 

While debt funds carry the lowest risk, certain hybrid funds are also relatively low-risk: For example, conservative hybrid funds allocate 75 to 90% of their assets in debt instruments, which makes them less volatile. 

Suitability Of Low-Risk Funds – Time Horizon and Goals

Low-risk funds are suitable for short-term goals, such as saving for a vacation or making a down payment within the next one to three years. They are ideal for parking money and earning returns without exposing it to extreme market volatility. 

Debt funds, such as overnight funds and liquid funds, are also useful in building an emergency corpus, as they are highly accessible and typically offer better returns than keeping money idle at home or in a low-interest savings account. 

Additionally, low-risk funds play an important role in creating a balanced portfolio by stabilising the impact of equity volatility. 

Challenges Associated With Low-Risk Funds

While low-risk mutual funds offer relative safety, they are not entirely risk-free. Here are some key challenges. 

1. Lower return potential: Compared to equities and most hybrid funds, debt funds carry lower risk but also offer lower return potential. In many cases, low-risk funds may not generate returns high enough to beat inflation. 
2. Exposure to various risks: Debt funds are subject to risks such as interest rate risk, credit risk, and reinvestment risk, any of which can lead to potential losses. 

How To Optimise Returns From Low-Risk Mutual Funds: Best Practices

Here are some smart strategies to follow to optimise returns:

1. Diversify your investment: There are different types of low-risk mutual funds. Spread your investment across instruments with different credit ratings, issuers, and industries. You can also mix different investment styles, such as active and passive.  
2. Match your risk appetite: Even within the low-risk category, the risk level differs. Ensure your chosen fund aligns with your risk appetite. Taking on more risk than you can handle may lead to potential losses, while being unnecessarily conservative could mean missing out on growth opportunities. 
3. Align with your investment horizon: Different debt funds come with varying maturity periods. Ensure your fund aligns with your investment horizon to avoid liquidity issues and enjoy better yields. 
4. Consider taxation: Debt funds and hybrid funds are taxed differently. Consider the tax implications of both to minimise taxes and maximise post-tax returns. 
5. Use investment strategies: Strategies like Systematic Investment Plans (SIPs) and STPs are smart ways of tackling market volatility. SIPs spread investments across market cycles and average out costs over time. STPs let you park a lump sum in a safer fund and gradually move it into a higher-yielding one, ensuring your money isn’t exposed to market risk all at once.  
6. Seek professional help: Financial advisors can help you choose the right low-risk mutual funds tailored to your financial profile, goals, time horizon, and risk appetite. 

Conclusion

Just as high risk doesn’t always guarantee high returns, low risk doesn’t always mean low returns. With smart strategies, low risk mutual funds can deliver steady growth while protecting capital, making them ideal for cautious investors.

Additional Read: What are mutual funds - Guide for Beginners