Banking and PSU funds are debt mutual funds that mainly invest in debt and money market instruments issued by banks, public sector undertakings (PSUs), public financial institutions (PFIs), and municipal bodies.

Some familiar names you may see in these portfolios include SBI, Power Grid, NTPC, REC and NABARD. Depending on their investment strategy, these funds may also invest in debt issued by private banks such as HDFC Bank.

As per SEBI rules, a banking and PSU debt fund must invest at least 80% of its total funds in debt instruments of banks, PSUs, PFIs, and municipal bonds. This makes the scheme different from equity funds, where your returns are closely linked to stock prices.

Banking PSU mutual funds are generally considered lower-credit-risk debt funds as they focus on institutions with strong credit profiles. However, interest rate changes or credit quality can still affect their NAV.

Banking and PSU mutual funds may suit you if:

• If you want a debt fund focused on banks and large PSUs: These funds can be useful if you want exposure to high-quality debt without choosing individual bonds yourself.
• If you have a medium-term investment goal: These schemes can fit goals that are a few years away, depending on the fund’s duration and your risk tolerance. For very short-term needs, overnight funds, money market funds or ultra-short-duration funds may be more suitable.
• If you want to balance a portfolio with equity exposure: If you invest in growth-oriented schemes such as multi-cap funds, large cap funds, mid-cap funds or small-cap funds, this debt scheme can add a different type of exposure to your portfolio.
• If you prefer lower credit risk: Banking PSU schemes focus on a defined set of issuers rather than taking large exposure to lower-rated corporate debt. If you compare them with credit risk funds, the risk profile can differ significantly.

When you invest in a banking PSU mutual fund scheme, your money is pooled with other investors' money. The fund manager then uses this pool to buy debt and money market instruments issued by eligible banks, PSUs, PFIs and other permitted issuers.

The fund earns returns in two ways:

• Interest income, and
• Capital appreciation from changes in bond prices.

When market interest rates fall, bond prices rise. This can increase the fund’s NAV. However, the opposite can happen when interest rates rise.

Let’s consider a scenario where you invest ₹10,000 in a banking PSU mutual fund when its NAV is ₹20. You will receive 500 units of the fund (₹10,000/₹20).

Now imagine the portfolio earns an interest income of around 7.4% a year, with no major changes in bond prices. Your investment could look roughly like this:

This is only an illustration using a constant 7.4% annual return. Actual banking and PSU fund returns can be higher or lower as bond prices, interest rates, expenses and portfolio holdings can change.

So, unlike an FD where the interest rate is fixed, these schemes give you market-linked returns, which may not remain constant.

You may get several benefits from your banking and PSU fund investment, such as:

• Exposure to established issuers: It helps keep the credit risk lower than funds that take significant exposure to lower-rated corporate borrowers.
• Potential to benefit from falling interest rates: If market interest rates fall, the prices of existing bonds can rise. This can give the fund capital gains in addition to its interest income.
• Useful for portfolio diversification: These schemes can add balanced debt exposure to a portfolio that contains only equity mutual fund schemes.
• More flexible than fixed-tenure investments: Banking PSU mutual funds are open-ended schemes, so you can redeem your units when you need the money, subject to the scheme’s rules and any exit load.

Banking PSU schemes are widely considered safer than other debt funds, but they still carry some important risks, such as:

• Interest rate risk: If interest rates rise, bond prices fall. This can cause the fund’s NAV to decline in the short term. Schemes holding longer-duration bonds are generally more sensitive to such changes.
• Reinvestment risk: When a bond matures, the fund manager has to invest that money again. If market rates are lower at that point, the new investment may offer a lower yield.
• Credit risk: Although these schemes focus on banks, PSUs, and PFIs, that doesn’t mean all holdings are equally safe or that there is zero chance of default. Maintaining credit quality is still important.
• Underperformance risk: Debt funds generally do not have the same return potential as equity categories such as blue-chip funds or index funds over long periods. They serve a different purpose.

While both these schemes are considered safer debt funds, one lends to government entities and the other to India’s top companies. Here’s a quick comparison:

If you prefer lower interest-rate exposure, you can look at schemes such as ultra-short duration funds, low duration funds, or short duration funds.

Don’t choose banking PSU funds to invest in simply by looking at which one gave the highest return in the last 6 months. Instead, look for:

• Credit quality: Look at the fund’s latest portfolio and see what kind of issuers it holds and what their credit rating are.
• Average maturity: Compare the fund’s maturity profile with how long you plan to stay invested.
• Portfolio concentration: Check whether the fund is heavily dependent on a small number of issuers.
• Expense ratio: Lower costs can help you retain more of the fund’s returns over time. You can prefer the direct-growth option over regular plans for lower costs.
• Consistency: Look at performance across different interest-rate environments instead of focusing only on the latest return.

Remember, the best banking PSU mutual funds don’t just perform well when interest rates fall. They consistently deliver steady returns over the years.

Setting up an SIP in top-rated banking PSU funds is super easy with Millions. All you need to do is:

• Install the Millions app on your smartphone
• Enter your mobile number and verify your details to complete the KYC.
• Once your free account is open, head to the mutual funds section.
• Search for banking PSU funds to invest in, and select the scheme that meets your requirements.
• Tap on ‘SIP’ and select your preferred frequency (daily, monthly or weekly).
• Enter the SIP amount, choose your debit date, and authorise the first payment.

Your SIP is officially active! While banking and PSU funds take care of your medium-term investment goals, you can explore other categories for long-term goals. For equity exposure, consider large-cap funds or Nifty 50 funds. For a mix of asset classes, you can also consider multi-asset allocation funds or conservative hybrid funds.