Debt Mutual Funds
Debt is the major markets in which people invest their hard-earned money to make profits. The debt market consists of various instruments which facilitate the buying and selling of loans in exchange for interest. Considered to be less risky than equity investments, many investors with a lower risk tolerance prefer buying in debt securities. However, debt investments offer lower returns as compared to equity investments. Here, we will explore Debt Funds and talk about different types of debt funds along with their benefits and a lot more.
What is a Debt Fund?
Debt funds invest in securities which generate fixed income like treasury bills, corporate bonds, commercial papers, government securities, and many other money market instruments. All these instruments have a pre-decided maturity date and interest rate that the buyer can earn on maturity – hence the name fixed-income securities. The returns are usually not affected by fluctuations in the market. Therefore, debt securities are considered to be low-risk investment options.
How do Debt Funds work?
Every debt security has a credit rating which allows investors to understand the possibility of default by the debt issuer in disbursing the principal and interest. Debt fund managers use these ratings to select high-quality debt instruments. A higher rating implies that the issuer is less likely to default.
The next logical question is:
Do Debt Funds also invest in low-quality debt instruments?
The answer is yes. Fund managers select securities based on various factors. Sometimes, choosing low-quality debt security offers an opportunity to earn higher returns on debt investments and the fund manager takes a calculated risk. However, a debt fund which has high-quality securities in its portfolio will be more stable. Further, the fund manager can choose to invest in long-term or short-term debt securities depending on whether the interest rate regime is falling or rising.
Who should invest in Debt Mutual Funds?
Debt funds are highly recommended to investors with lower risk tolerance. Debt funds usually diversify across various securities to ensure stable returns. While there are no guarantees, the returns are usually in an expected range. Hence, low-risk investors find them ideal. Debt funds are also available for:
- Short-term investors (3-12 months) – Rather than keeping your funds in a regular savings account, you can invest in liquid funds which offer 7-9% returns. Also, you do not compromise on liquidity.
- Medium-term investors (3-5 years) – If you want to invest in a low-risk instrument for 3-5 years, the first thing that probably comes to mind is a bank fixed deposit. Investing in a dynamic bond fund for a similar tenure tend to offer better returns than FDs. Also, if you need monthly payouts (like interest in FDs), you can opt for a Monthly Income Plan.
Types of Debt Funds
Based on the maturity period, debt funds can be classified into the following types:
- Liquid Fund – which invests in money market instruments having a maturity of maximum 91 days. Liquid funds tend to offer better returns than savings accounts and are a good alternative for short-term investments.
- Money Market Fund – which invests in money market instruments with a maximum maturity of 1 year. These funds are good for investors seeking low-risk debt securities for a short-term.
- Dynamic Bond Fund – which invests in debt instruments of varying maturities based on the interest rate regime. These funds are good for investors with moderate risk tolerance and an investment horizon of 3 to 5 years.
- Corporate Bond Fund – which invests a minimum of 80% of its total assets in corporate bonds having the highest ratings. These funds are good for investors with lower risk tolerance and seeking to invest in high-quality corporate bonds.
- Banking and PSU Fund – which invests at least 80& of its total assets in debt securities of PSUs (public sector undertakings) and banks.
- Gilt Fund – which invests a minimum of 80% of its investible corpus in government securities across varying maturities. These funds do not carry any credit risk. However, the interest rate risk is high.
- Credit Risk Fund – which invests a minimum of 65% of its investible corpus in corporate bonds having ratings below the highest quality corporate bonds. Therefore, these funds carry an amount of credit risk and offer slightly better returns than the highest quality bonds.
- Floater Fund – which invests a minimum of 65% of its investible corpus in floating rate instruments. These funds carry a low interest-rate risk.
- Overnight Fund – which invests in debt securities having a maturity of 1 day. These funds are considered to be extremely safe since both credit risk and interest rate risk is negligible.
- Ultra-Short Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is between three and six months.
- Low Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is between six and twelve months.
- Short Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is between one and three years.
- Medium Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is between three and four years.
- Medium to Long Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is between four and seven years.
- Long Duration Fund – which invests in money market instruments and debt securities in a manner that the Macaulay duration of the scheme is more than seven years.
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