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A Guide to Debt Funds – All About Debt Funds

Debt funds are fast gaining popularity among Indian investors, thanks to the prevailing volatile market conditions. Mentioned in this post are the details that you must know about debt funds. Read on to know more.

Debt funds have become a popular term among investors, especially when it is compared to different investment options such as stocks, equity funds, etc. People often wonder about what is a debt fund. Though equity funds are known for generating higher returns, debt funds are known for its low-risk factor.

Understanding Debt Funds

Investing in a debt fund is similar to lending money and earning interest in return, along with capital appreciation. A debt fund is a mutual fund that generates returns for its investors by investing in a variety of fixed income bonds and deposits such as corporate bonds, treasury bills, government securities, etc. It aims to accumulate profits in the form of fixed interest earned and probable appreciation of principal investment during the tenure of the debt fund. The issuer states the interest rate at the time of purchase.

Debt funds are suitable for conservative investors who prefer low and steady income over fluctuating equity markets that are known for higher returns.

Working of Debt Fund Investments

  • Debt funds are invested in bonds or securities of higher credit ratings, which improve chances of timely and assured interest along with the principal amount on maturity.

  • The fund manager is responsible for deciding the investment strategy and aligning it as per the interest rate fluctuations.

  • The maturity of funds is guided by the investment strategy of the fund manager and the overall trend of interest variations.

Different Types of Debt Funds:

    Overnight Funds:

  • These are open-ended debt mutual funds that come with an investment period of one day.

  • Due to the single-day period, interest fluctuations are minimal, and hence they are considered to be safer investments.

    Short/Ultra-Short Duration Funds:

  • Ultra-short duration funds invest in debt investments that mature within 3-6 months, whereas short duration funds mature between 1-3 years.

  • Since both the funds invest for a relatively shorter duration, there is a lesser risk of interest rate variations.

    Liquid Funds:

  • Liquid funds also invest in short duration bonds and securities that mature within 91 days of investment.

  • If you wish to invest for a smaller period with minimal risk-bearing, liquid funds can be a good option.

    Corporate Bonds:

  • These funds invest almost 80% of the total funds in high rated corporate securities or bonds.

  • They can potentially generate higher returns in comparison to short term debt funds.

    Credit Risk Funds:

  • Credit risk funds aim to earn better returns by deciding upon the credit risks and investing in lower-rated securities offering higher interest rates.

  • These funds have a relatively higher risk.

    Dynamic Bond Funds:

  • For dynamic bond funds, the fund manager keeps altering the composition of the portfolio as per the changing interest rates.

  • According to variations in interest rate, investment is made in both long-term and short-term bonds.

    Income Funds:

  • Income funds are dependent on interest rates and invest primarily in debt securities with a higher maturity period.

  • Due to an extended maturity period, it tends to be more stable in comparison to dynamic bond funds.

    Gilt Funds:

  • Gilt funds invest only in low-risk government bonds and securities which are generally high-rated.

  • Due to the single-day period, interest fluctuations are minimal, and hence they are considered to be safer investments.

    Fixed Maturity Plans:

  • FMPs also invest in corporate bonds and government securities that offer fixed income during a fixed tenure.

  • Since it is close-ended, the money gets locked-in for a specific time.

How to Select a Debt Fund?

    Below points should be considered before choosing the right fund for yourself:

  • Investment tenure

    You should choose a debt fund keeping in mind the tenure for which you wish to invest. Accordingly, it can be short-term, ultra-short-term, long-term, etc. Generally, for greater tenure, higher returns can be expected.

  • Category of fund:

    As per your requirements and investment tenure, there are different categories of funds such as monthly income plans, fixed maturity plans, credit risk fund, short term, and long-term funds, etc. The one which is most relevant to your needs should be picked.

  • Investment objective:

    Do you wish to invest in additional income? Do you need returns early or in the long-run? The answers to these questions can help you pick the right debt fund.

  • Risk:

    Though debt funds are less volatile than equities, they have credit risk and risk related to interest rates. You should be well informed of the associated risk before choosing the debt fund.

  • Returns:

    Though debt funds are known to be fixed-income securities, there is no guarantee of returns. It depends on the overall interest rates prevailing in the economy. Hence, you should be aware of the factors affecting returns on your investment.

Stabilise Your Returns With Debt Funds:

Debt mutual funds are relatively isolated from the volatility of the market and hence are safer than equity funds. As fixed-income securities, the investor is aware of the expected returns since the time of investment. Therefore, it is an excellent choice for new and conventional investors with a low-risk appetite.