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Debt funds, as the name suggests, invest in fixed income debt instruments. Debt instruments pay regular interest and also redeem the principal on the completion of the tenure of the instrument. For example a 9% bond redeemable after 5 years with a face value of Rs.1000 will pay Rs.90 as interest each year and at the end of the fifth year it will pay Rs.1090, which will include the redemption of the principal. Compared to equity funds, debt funds are lower on the risk scale and also give more stability and regularity to income flows, which is why it is more preferred by conservative investors. Like equity funds create a pool of equity assets, debt funds create a pool of debt assets which include government bonds, corporate bonds, treasury bills, commercial paper, certificates of deposit etc.
Debt funds are typically classified based on their duration or their credit risk. In terms of duration, a debt fund can be a liquid fund, short term debt fund, income fund or a long term gilt fund. In terms of credit risk, debt funds can be classified as G-Sec funds or credit opportunities funds.
Debt funds are a pool of bond assets that investors can invest in. Unlike in the case of equity funds where the investors are predominantly individual investors, the debt funds have a large chunk of institutional investors like banks, pension funds, NBFCs, corporates etc. Debt funds typically invest in a mix of debt instruments (also called fixed income instruments) such as treasury bills, government securities, corporate bonds, and institutional bonds, call money, CP, CD etc. Generally, all debt securities have a fixed maturity and also pay fixed assured returns to bond holders. Debt funds create a diversified pool of debt assets by investing across a wide class of debt instruments.
Like in the of equity funds, debt funds also announce daily net asset value (NAV). These are announced each day evening and the next day investments and redemptions happen at a price based on this NAV. Debt funds invest in debt instruments for two reasons. They invest for interest income, which is regularly paid out by the bond issuers. Secondly, debt funds also invest for capital appreciation in bonds. How do bonds appreciate? Bond prices are inversely related to the yields in the market. For example, when the interest rates go up (RBI raises repo rates) then the bond yields go up and the bond prices go down resulting in capital loss. When the interest rates go down (RBI cuts repo rates) then the bond yields go down and the bond prices go up resulting in capital appreciation. Debt funds offer a wide variety based on duration and risk profile and investors can choose what suits them best. Debt instruments (bonds) issued is assigned credit ratings. Normally, G-Secs and Treasury Bills of the government are “AAA” rated but corporate bonds will have lower ratings based on risk perception. Debt funds also constantly trade these bonds in the market.
Bond funds or debt funds can be classified based on their maturity and their risk profile. We can also have open ended funds that are available for entry and redemption at any point of time. Then we have closed end funds that are only open for a fixed period and then it is closed and listed on the stock exchange. Fixed Maturity Plans (FMPs) are a very popular form of closed ended bond funds. Let us now focus on some key types of open ended funds.
Debt funds can appeal to different classes of investors; both retail and institutional. Let us look at some of the classes of investors who should be investing in debt funds.
Here are some of the key benefits that you can get by putting money in debt funds.
There is a strong element of fund selection in debt funds too. Here are the critical factors that you need to consider when investing in debt funds.
Debt funds and equity funds differ on the assets that they invest in. While equity funds are predominantly invested in large and mid cap stocks based on their investment objective, debt funds spread their funds between various debt instruments. Here are some key differences.
A common question that a lot of debt fund investors have is whether the NAV of a debt fund can actually fall since the fund is invested in assured return bonds. NAV or the Net asset value of the fund is the market value of its bonds (minus expenses) divided by the number of units outstanding. There are two common cases where the NAV of the debt fund can fall.
Choosing a debt fund typically involves the following four stages that you need to navigate.
Fund selection is only one part of the story. Once you invest in a debt fund you need to evaluate the fund on a regular basis and also evaluate the need to rebalance your debt fund portfolio if required. Here are five points to consider.