Best Debt Funds: Who should Invest and How to invest in Debt Funds

Last Updated: 20 Oct 2023

Debt funds that invest in debt instruments. These can be short duration instruments or long duration instruments. These can be short term liquid funds or long term G-Sec funds. They can be funds on corporate debt or a combination of these. Even within corporate debt funds, these debt funds can be high credit quality or mid credit quality funds. There is a huge choice in short.

Can you tell me the best performing gilt and corporate bond funds?

Here is a list of top performing gilt funds in India based on the NAV as on 07-January. These are based on 5-year returns.

Scheme Name	NAV Direct	Return 1 Year (%) Direct	Return 3 Year (%) Direct	Return 5 Year (%) Direct
IDFC GSF Investment Fund	30.08	2	10.39	8
Edelweiss Government Securities Fund	21	4.55	10	8.24
Nippon India Gilt Securities Fund	33.79	2.34	9.50	8.04
DSP Government Securities Fund	79.49	3.27	10.21	8
Aditya Birla Sun Life G-Sec Fund	69	3.61	10	7.7
SBI Magnum Gilt Fund	54.13	3	9.88	7.66
Kotak Gilt Investment Fund	85.5	2.76	9.57	7.32
ICICI Prudential Gilt Fund	84.82	3.43	9.33	7.25
LIC MF GSF Fund	52.7	2.23	8.85	7.06
Axis Gilt Fund	21.34	2.78	9.70	7.03
PGIM India Gilt Fund	25.68	3.71	8.41	6.93
UTI Gilt Fund	51.68	2.22	8.44	6.81
L&T Gilt Fund	59.98	1.14	8.13	6.43
Canara Robeco Gilt Fund	64.52	2.30	8.15	6.38
Baroda Gilt Fund	36.78	2.07	7.82	6.23
Tata GSF	67.76	0.98	7.57	6.22
HDFC Gilt Fund	46.37	2.1	7.51	5.76
Invesco India Gilt Fund	2,445.69	0.81	6.95	5.63
Franklin India G-Sec Fund	52.29	2.27	6.82	4.9
IDBI Gilt	18.5	2.01	6.67	4.8

Here is a list of top performing Corporate Bond funds in India based on the NAV as on 07-January. These are based on 5-year returns.

Scheme Name	NAV Direct	Return 1 Year (%) Direct	Return 3 Year (%) Direct	Return 5 Year (%) Direct	Daily AUM (Cr.)
Nippon India Corporate Bond Fund	49	4.94	8	7.46	3,912
PGIM India Premier Bond Fund	38	4.48	8	7.14	67.70
Axis Corporate Debt Fund	14.1	4.14	7.76		4,701.66
ICICI Prudential Corporate Bond Fund	24.36	4	8.33	8	18,942.65
Franklin India Corporate Debt Fund	84.66	4	7.8	7.92	821.87
Aditya Birla Sun Life Corporate Bond Fund	90.07	3.95	8.55	7.79	19,375.17
Kotak Corporate Bond Fund	3,099.89	3.82	7.88	7.67	10,869.86
HDFC Corporate Bond Fund	26.21	3.79	8.79	7.78	28,123.94
Sundaram Corporate Bond Fund	33.14	3.6	8.82	7.39	1,075.24
IDFC Corporate Bond Fund	15.86	3.57	8.09	7.38	19,922.96
Invesco India Corporate Bond Fund	2,706.29	3.53	8.5	6.33	3,522.25
L&T Triple Ace Bond Fund	62.27	3.49	9.92	7.27	9,592.12
DSP Corporate Bond Fund	13.17	3.47	8.1		2,060.65
UTI Corporate Bond Fund	13.27	3.46	8.79		4,431.67
Canara Robeco Corporate Bond Fund	18.69	3.2	7.9	7.05	260.09
HSBC Corporate Bond Fund	10.57	3.11			229.77
SBI Corporate Bond Fund	12.64	3.09			22,286.61
Union Corporate Bond Fund	12.53	2.7	6.15		444.23
BNP Paribas Corporate Bond Fund	23.27	2.37	4.64	5.27	31.08

Data Source: AMFI

Corporate bond funds have a total AUM of Rs.151,700 crore and are among the more popular debt fund categories.

How to choose a suitable debt fund…

The choice of a debt fund will largely depend on your return expectations, your risk appetite and your liquidity requirement. Here are 3 things to keep in mind while choosing a debt fund for your portfolio…

• Check if your risk tolerance matches with the credit profile of the fund. If you want a zero risk fund, stick to a gilt fund as they do not carry any credit risk. If you are aggressive and can afford to take higher risk for higher returns than you can look at MIPs, credit opportunity funds etc.
• Check out your time horizon. If you require money within 1 year do not invest in a long term debt fund where instruments will typically have a maturity of more than 5 years. You can either go for a short term debt fund or more preferably go for a liquid or an Ultra Short Term fund.
• Your choice of debt fund should be based on your assessment of where interest rates are headed as it is the most critical factor determining debt fund returns. For example, if your view is that rates are headed down, then you can focus on long term debt funds or gilt funds. If your view is that rates are headed higher, then you must either stick to liquid funds or go for floating rate funds. A word of caution! Your interest rate view must be fine-tuned in consultation with your financial advisor as it is a complex subject.

How to evaluate debt funds:

There are a variety of very complex methodologies to evaluate a debt fund. But from a very simple perspective, you need to consider 3 key factors while evaluating a debt fund…

• A debt fund holds a mixture of bonds ranging from 1-year bonds to 10-year bonds. The best approximation is to consider the average maturity of the fund. This needs to be compared with your time horizon. If you are looking to liquidate your debt funds with 1 year or 3 years, then look for a fund with an average maturity that approximately matches your time horizon. That will reduce your liquidity risk substantially.
• Modified duration is another measure that is quite important from the point of view of evaluating a debt fund. Technically, modified duration shows the weighted average number of years it takes to recover your principal, where interest payments are also considered as part repayment of principal. Therefore, the modified duration will always be lower than the average maturity, except in case of deep discount bond where the modified duration will be equal to the maturity. What investors need to remember here is that higher the modified duration (MD), higher is the sensitivity of bond prices to movement in interest rates?
• Yield to Maturity (YTM) is a basic measure of returns on the fund. It calculates what the bond fund will earn through dividends plus capital gains. Normally, higher the YTM, the better it is for debt fund investors.

Fixed maturity plans (FMP):

A fixed maturity plan (FMP) is a closed-ended debt fund. A closed ended fund is one that is not open to continuous investment and redemption like normal open-ended mutual funds. Once you determine the lock-in period and invest in the FMP, your funds are locked in for the stated period. FMPs. Typically, the most popular FMPs are the 3-year FMPs as that is the cut off for classifying debt fund gains as long term capital gains. Below 3 years, gains on debt funds are classified as short term capital gains and taxed at the peak rate of tax of the investor. FMPs are predominantly invested in debt instruments with approximately similar maturity as the maturity of the FMP.

FMPs have become quite popular due to some of their innate qualities. Firstly, being debt oriented the risk of capital loss is very limited. Secondly, since it is closed ended, there is no interest rate risk on these funds. When redeemed after 3 years, the gains qualify as long term gains and are taxed at 20% after indexation, which normally reduces the incidence of tax to below 10%. The most important factor about FMPs is that the maturity of the investment is matched to the maturity of the FMP virtually making it an assured return investment. Of course, being closed-ended funds, they are listed on the stock exchanges, but since trading is negligible the secondary market liquidity is almost absent.