What are ‘DEBT FUNDs’ ?
There are different types of Mutual Funds that invest in various securities, depending on their investment strategy.Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Generally, debt securities have a fixed maturity date & pay a fixed rate of interest.
The returns of a debt mutual fund comprises of –
- Interest income
- Provident fund
Debt securities are also assigned a ‘credit rating‘, which helps assess the ability of the issuer of the securities / bonds to pay back their debt, over a certain period of time. These ratings are issued by independent rating organisations such as CARE, CRISIL, FITCH, Brickwork and ICRA. Ratings are one amongst various criteria used by Fund houses to evaluate the credit worthiness of issuers of fixed income securities.
There is a wide range of fixed income or Debt Mutual Funds available to suit the needs of different investors, based on their:
- Investment horizon
- Ability to bear risk
Different types of Debt Mutual Funds
There are different types of Debt Mutual Funds that invest in various fixed income securities of different time horizons. Some of the debt based & blended category products (which have both debt and equity allocation) are as follows –
These funds invest in highly liquid money market instruments and provide easy liquidity. The period of investment in these funds could be as short as a day. They aim to earn money market rates and could serve as an alternative to corporate and individual investors, for parking their surplus cash for short periods. Returns on these funds tend to fluctuate less when compared with other funds.
Ultra Short Term Funds
Earlier known as Liquid Plus Funds, they invest in very short term debt securities with a small portion in longer term debt securities. Most ultra short term funds do not invest in securities with a residual maturity of more than 1 year. Also referred to as Cash or Treasury Management Funds, Ultra Short Term Funds are preferred by investors who are willing to marginally increase their risk with an aim to earn commensurate returns. Investors who have short term surplus for a time period of approximately 1 to 9 months should consider these funds.
Floating Rate Funds
These funds primarily invest in floating rate debt securities, where the interest paid changes in line with the changing interest rate scenario in the debt markets. The periodic interest rate of the securities held by these products is reset with reference to a market benchmark. This makes these funds suitable for investments when interest rates in the markets are increasing.
Short Term & Medium Term Income Funds
These funds invest predominantly in debt securities with a maturity of upto 3 years in comparison to a Regular Income Fund. These funds tend to have a average maturity that is longer than Liquid and Ultra Short Term Funds but shorter than pure Income Funds. These funds tend to perform when short term interest rates are high and could potentially benefit from capital gains as liquidity comes back to the market and interest rates go down. These funds are suitable for conservative investors who have low to moderate risk taking appetite and an investment horizon of 9 to 12 months.
Income Funds, Gilt Funds and other dynamically managed debt funds
These funds comprise of investments made in a basket of debt instruments of various maturities & issuers. These funds are suitable for investors who willing to take a relatively higher risk as compared to corporate bond funds,and have longer investment horizon. These funds tend to work when entry and exit are timed properly; investors can consider entering these funds when interest rates have moved up significantly to benefit from higher accrual and when the outlook is that interest rates would decrease. As interest rates go down, investors can potentially benefit from capital gains as well. A few types of dynamically managed debt funds are mentioned below –
- Income funds invest in corporate bonds, government bonds and money market instruments. However,they are highly vulnerable to the changes in interest rates and are suitable for investors who have a long term investment horizon and higher risk taking ability. Entry and exit from these funds needs to be timed appropriately. The correct time to invest in these funds is when the market view is that interest rates have touched their peak and are poised to reduce.
- Gilt Funds invest in government securities of medium and long term maturities issued by central and state governments. These funds do not have the risk of default since the issuer of the instruments is the government. Net Asset Values (NAVs) of the schemes fluctuate due to change in interest rates and other economic factors. These funds have a high degree of interest rate risk, depending on their maturity profile. The higher the maturity profile of the instrument, higher the interest rate risk
- Dynamic Bond Funds invest in debt securities of different maturity profiles. These funds are actively managed and the portfolio varies dynamically according to the interest rate view of the fund managers. These funds Invest across all classes of debt and money market instruments with no cap or floor on maturity, duration or instrument type concentration.
Corporate Bond Funds
These funds invest predominantly in corporate bonds and debentures of varying maturities that offer relatively higher interest, and are exposed to higher volatility and credit risk. They seek to provide regular income and growth and are suitable for investors with a moderate risk appetite with a medium to long term investment horizon.
Benefits of investing in Debt Mutual Funds
The various benefits of investing in Debt Mutual Funds are listed below –
Your investments are not affected by equity market volatility
Debt Mutual Funds invest in a range of interest bearing instruments such as Treasury Bills, Government Securities, Corporate Bonds, Money Market Instruments and other debt securities.
Add stability to your investment portfolio
As Debt Mutual Funds mainly invest in debt securities, they are relatively more stable than equity investments. They can also lend stability to your equity portfolio by reducing the risk associated with your complete investment portfolio.
Freedom to withdraw your money when required
All open ended mutual funds give you the freedom to withdraw your money as and when required, although your investments may be subject to an exit load. Close ended mutual funds have a defined maturity date. Such funds are listed and can be traded on the stock exchange.
You can aim for better post tax returns
Earnings from debt instruments can come in two forms:
- Dividend or interest payments
- Capital gains based on the difference between the purchase price and the sale price of the debt security
Tax on dividend / interest income : Dividend distribution Tax (DDT) is broken up into the following
- Dividend for individual v/s non-individual investors and
- Dividend from liquid v/s non-liquid funds
How to choose a Debt Mutual Fund
Earnings from debt instruments can come in two forms:
- Ask yourself the following questions Before deciding in which Debt mutual fund product to invest, it’s important that you answer the following questions –
- What is my investment objective?
- What is my investment horizon?
- How much risk am I willing to take?
- Understand the Market Environment Keep in mind that you must also consider various market factors such as –
- Would interest rates rise in the near term?
- How are the interest rates likely to move over the next few years?
As you may not be able to answer these questions yourself, you should seek advice from your distributor or keep yourself abreast with information available on the Market Reports section on our website.
- Assess you current Asset Allocation it is also important for you to consider your overall asset allocation, the ratio of equity to debt in your complete investment portfolio, while deciding where to invest. Maintaining a good balance between equity and debt investments is essential to provide stability and the potential for growth in the long run.
- Identify the Type of fund that suits your needs Depending on how you answer the questions above, you could seek assistance from your distributor to select an appropriate fund to match your needs. Click on the link below to understand what points you need to consider before investing in a Debt Mutual Fund.