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Debt Mutual Funds



Lately, We have been discussing various financial instruments to help you build a diversified portfolio and start investing according to your financial objectives. If you are someone who wants to invest without taking risk of equity instruments, you can invest in various debt instruments as they are less riskier than equity and offer both a fixed maturity period and regular interest payments. So, let’s explore Debt Mutual Funds and how it can supplement your objectives!


If you are one of our subscribers, you might know what a Mutual fund is, and if not, click here to read


Now, let's discuss debt mutual funds?

Debt fund refers to a mutual fund or an exchange-traded fund (ETF) whose underlying investment consists chiefly of fixed income securities, or we can say it invests in securities which generate fixed income like treasury bills, corporate bonds, commercial papers, government securities,money market instruments,etc. These Instruments are called Fixed Income securities as they have a pre-decided maturity date and interest rate that an investor can earn. Hence, these instruments are considered less risky and involve less fees as compared to equity. 


How do they work?

Every debt security has a credit rating which helps investors as well as fund managers to assess the risk and return perspective of a particular debt instrument. A high rating implies that the issuer is less likely to default. Independent rating organizations such as CARE, CRISIL, FITCH, Brickwork and ICRA issue the ratings. Debt fund managers invest not only in high rated securities but also in the ones with low ratings depending upon the fund you have invested in. So, it becomes crucial for investors to choose a particular debt fund wisely after considering where they actually invest in!


Debt funds are considered ideal for investors with low risk tolerance as funds collected are diversified across various securities to help earn stable returns. Debt funds are also available for short term investors (3-12 months) with a return of 7-9% and long term investors (3-5 years). Long term investment in debt funds can offer a much better return than bank FDs and even can provide regular monthly income depending on the plan you chose. Investors interested in debt funds can choose between active and passive products. (Passive products replicate top fixed income benchmark indices whereas active securities aims to outperform them)


Let’s now look at the categorization of debt funds

SEBI has categorized debt funds into 15 considering the period of maturity and degree of risk involved. As a rule, if you have a low risk appetite and don’t want to take interest rate risk, you should purchase short term securities like liquid, ultra short duration funds. Credit risk funds should be invested in only if you want to take risk while earning returns. 


Lets, look at the list of debt mutual funds that will help you choose which debt fund suits your profile and risk appetite the most:

  1. Overnight Funds: This scheme is suitable for ultra conservative investors as it involves investment in overnight funds with maturity of a day.

  2. Liquid Funds: It is considered as one of the safest investment options for investors. These schemes invest in securities with maturity up to 91 days.

  3. Ultra short duration funds: These schemes invest in debt and money market instruments with maturity periods ranging from 3 months to 6 months. The actual period depends on how much time it takes to recoup the investment. 

  4. Low duration funds: This scheme also invests in debt instruments with maturity period ranging from 6 to 12 months depending when the investments will recoup.

  5. Money market funds: As the name suggests, this scheme invests in money market instruments with maturity upto one year.

  6. Short duration funds: These schemes invest in money market and debt instruments with a Macaulay duration of one to three years.

  7. Medium duration funds: These schemes invest in money market and debt instruments with duration of three to four years.

  8. Medium to long duration funds: These schemes invest in money market and debt instruments with a duration of four to seven years.

  9. Long duration funds: These schemes invest in money market and debt instruments with a Macaulay duration of more than seven years.

  10. Dynamic bond funds: This scheme is best for investors who don't want to take a call on the interest rates as fund managers have the freedom to invest across securities and maturities based on their outlook. That’s why they are known as dynamic funds.

  11. Corporate bond funds: This scheme is considered relatively safe as they have the mandate to invest at least 80% of their portfolio in high rated corporate bonds.

  12. Credit Risk Funds: These are considered to be the riskiest schemes as highlighted above as they invest usually in below high rated corporate bonds. As per SEBI guidelines, they have to at least invest 65% of their portfolio in low rated corporate bonds.

  13. Banking & PSU funds: Fund managers invest at least 80% of the total assets in public sector undertakings, debt instruments of banks and public financial institutions.

  14. Gilt Funds: These schemes invest 80% of their assets in government securities across maturities.

  15. Gilt funds with 10 year constant duration: These schemes must invest at least 80% of their assets in government securities with a maturity of 10 years.


Risk in Debt funds

There are broadly three types of risks faced while investing in debt funds which an investor should consider while investing:


1. Liquidity Risk: Risk carried by fund managers of not having adequate liquidity to ensure immediate redemption.


2. Credit Risk: This is the default risk where interest and principal payments are not repaid.


3. Interest Rate risk: This implies the risk of changing interest rates on the value of a scheme's securities.


You can also consider the tax implications being classified as STCG upto three years of maturity taxed at normal slab rates or LTCG with more than three years of maturity taxed at 20% with indexation benefits.


We hope that now you have got all information regarding debt funds and will consider it into your investment portfolio based on your financial objectives and investment profile. 

Happy Investing!

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