Banking and PSU Fund: Definition, Features, Benefits & Tax Rules

Banking and PSU Fund can be defined as a type of debt fund that invests primarily i.e. minimum 80% of its portfolio in debt instruments such as bonds in India and money market securities issued by banking institutions and public sector undertakings. They provide a stable and secure investment platform, particularly for risk-averse investors.

For an investor’s perspective, this means that as per SEBI guidelines, the below types of investments would account for a major portion of the portfolio of a Banking and PSU Debt Fund:

• Banks' Investments: These is includes bonds, debentures and certificate of deposits (CDs) issued by leading banks in India.
• Public Sector Undertakings (PSUs): Highly rated bonds and commercial papers with credit rating of A1+ or AAA issued by Public Sector Undertakings.

These investments are typically high quality debt instruments, so they would feature a low coupon rate and relatively low yield. But these investments will have minimum credit and default risk for the investor. Due to these features, Banking & PSU Debt Fund investments are favored by conservative investors seeking potentially low risk debt investments even if overall returns are relatively low.

Banking & PSU Fund presents several unique features that can makes this type of mutual fund a fitting choice for various types of investors. Let's take a closer look at these key characteristics:

Taxation plays a significant role in determining the net return on investment from Banking and PSU funds. Understanding the taxation guidelines helps in making informed investment decisions:

•  Short-term Capital Gains (STCG): If the Banking and PSU Fund units are sold within three years from the date of investment, the gains are treated as short-term and taxed according to the investor's income tax slab.
•  Long-term Capital Gains (LTCG): If the units are held for more than three years, the gains are treated as long-term. Banking and PSU Fund taxation for LTCG is 20% with indexation benefits. This is not applicable for fund units bought on or after April 1, 2023. Now all gains are taxed as per the slab rate after redemption gains are added to the taxable income for the applicable fiscal under the head “income from other sources”.
•  Tax on Dividend: As per current rules, dividends received by the investor from Banking & PSU Debt Funds are complete taxable in the hands of the investor. The applicable tax rate in such cases is as per the income tax slab rate of the investor.

Knowing the applicable taxes can help in ensuring appropriate tax planning so that investors can optimize the net returns from their investment in a Banking and PSU Fund.

The appeal of Banking and PSU Fund lies in its ability to cater to various investor profiles. Let us check out who can be the potential investor of these funds:

• Short to Medium Term Investors: Those looking for a low volatility investment options for the short to medium term in order to achieve appropriate financial goals.
• Risk-Averse Investors: Being primarily invested in bonds issued by banks and public sector undertakings, these funds are often seen as a safer investment option, making them suitable for conservative investors.
• Diversification Enthusiasts: Investors aiming to diversify their portfolio across different sectors may leverage Banking and PSU Fund to achieve a balanced investment mix.

Investing in Banking and PSU Fund is a simple and straightforward process. Here's a step-by-step guide to help:

• Identify Your Investment Goals: Define your financial objectives, risk tolerance, and investment horizon to find a Banking and PSU Fund that aligns with your needs.
• Research and Compare: Explore various Banking and PSU Funds available in the market. Look into the fund's performance such as their annual, trailing and rolling returns; portfolio composition, expense ratio, and other relevant factors such as Macaulay and Modified Duration of the selected scheme.
• Consult a Financial Advisor: If needed, seek professional advice to identify the fund that best matches your investment profile.
• Complete KYC Requirements: Ensure that your Know Your Customer (KYC) formalities are completed.
• Invest Online or Offline: You can invest in Banking and PSU Fund through online platforms or by visiting the fund house's office.
• Monitor Your Investment: Regularly review the performance of your investment in Banking and PSU Fund and make necessary adjustments as per market dynamics and personal financial goals.

While Banking and PSU Fund investments come with their advantages, potential risks need to be understood and managed. Let us have a look at potential risks of these debt-oriented mutual funds and strategies to mitigate them:

• Interest Rate Risk: Fluctuations in interest rates can affect bond prices, impacting the Banking and PSU Fund's returns. Diversifying across various maturities can help in managing this risk.
• Credit Risk: There is a risk that the issuer of the bond may default on interest or principal payments. To mitigate this risk, investors should check the credit quality and ratings of the bonds as well as money market instruments held in the banking and PSU Fund portfolio.
• Liquidity Risk: At times, selling bonds in the portfolio may become challenging, affecting the fund's liquidity. Having a blend of highly liquid and less liquid assets can balance this risk.