Debt Funds: Meaning, Working, and Types
In simple words, Debt Funds from a company is their mode of raising funds by borrowing a certain amount from the investor against the promise of paying them a steady and regular interest
Let’s explore debt funds further.
What are Debt Funds?
Investing in Debt Funds is like giving loan to the issuing entity. A debt mutual fund invests in fixed-interest generating instruments like corporate bonds, government securities, treasury bills, and other money market instruments. As compared to equity mutual funds, they bear a very low risk as they remain unaffected from the market volatility and the issuer pre-decides the interest rate as well as the maturity period. Hence, as an investor, you know the return you will be getting for investing in Debt Mutual Funds.
How to Debt Funds work in India?
Debt Funds in India invest in different fixed-return securities based on their credit ratings. The credit rating of a security act as a parameter to ensure whether the issuer will default in distributing the returns they promised.
It is always recommended to invest in high credit quality instruments as the issuer entity for such instruments are more likely to pay the interest on the security as well as return back the principal amount upon maturity.
Debt Funds which invest in high-rated securities will be less volatile as compared to the low-rated securities. Also, the maturity period depends on the investment strategy and the overall interest rate regime in the country.
It is recommended to invest in long-term securities during the falling interest rate regime while a rising interest rate regime calls for investment in short-term securities.
Who should invest in Debt Funds?
Debt funds aim at optimizing returns by investing in different types of securities. Debt fund often gives decent returns but those returns are not guaranteed.
However, since the returns are already pre-decided by the issuer of the securities, investing in debt funds is safer for conservative investors who are not looking to take many risks with their investment. Unlike equity mutual fund which gives a better return in long-term, debt funds are suitable for those who are looking for fixed returns in short-term or medium-term which ranges from 3 months to 1 year and 3 years to 5 years, respectively.
Short-term Debt Funds
For a short-term investor, debt funds like liquid funds are a better fit instead of keeping the money in a savings bank account. Liquid funds offer higher returns ranging from 7%-9% along with similar liquidity to meet emergency requirements or short-term goals.
Medium-term Debt Funds
For those looking to invest neither for a short-term nor for the longer duration, dynamic bond funds can be an ideal fit. As compared to regular 5-year Bank Fixed Deposit, such bond funds offer higher returns.
People looking to earn a regular income from their investments can go with Monthly Income Schemes Debt Funds.
Types of Debt Funds
There are several types of debt funds suitable for different investors. The basic difference between the debt funds is regarding the maturity period of the instruments they invest in. Let’s take a look at different types of debt funds:
Short-term and Ultra short-term Debt Funds
These debt funds invest in instruments with shorter maturity tenure, ranging from 1-3 years. Such funds are ideal for conservative investors as the return on investment remains unaffected by interest rate movements.
The maturity of the instruments in Liquid Funds is not more than 91 days. With lowest maturity tenure, they are almost risk-free. As per the trend, liquid funds have rarely seen negative returns. They can be considered as a better alternative to the regular savings bank account as they provide similar liquidity with higher returns. Some mutual fund companies even offer instant redemption on liquid fund investments, which makes it easier for the investor to build liquidity through them.
Dynamic Bond Funds
When investing in Dynamic fund, the investment portfolio keeps changing the composition of funds as per the changing interest rate regime. Dynamic Bond Funds don’t have a fixed maturity period as it involves different instruments with different maturity tenure from short-term instruments to long-term instruments.
Just like dynamic bond funds, income funds also consider the changing interest rate and invest in debt securities with different maturity periods but generally, income funds invest in long-term securities. The average maturity of income funds is around 5-6 years which makes them more stable and less risky than dynamic bond funds.
These funds only invest in government securities which are usually high-rated securities with very low credit risk. Since the government rarely defaults on the loan it takes by issuing debt instruments, gilt funds becomes the ideal choice for the risk-averse investors.
Fixed Maturity Plans
Fixed Maturity Plans (FMPs) invest in fixed income securities like corporate bonds and government securities. All FMPs have a fixed lock-in period for the invested amount. This lock-in period can be in months or years. However, the only way to invest in FMPs is during the initial offer period. FMPs are like fixed deposits that can deliver higher, tax-efficient, but unguaranteed returns.
How to invest in Debt Funds?
With Karvy Online, investment in Debt Mutual Funds has been made paperless and hassle-free. All you have to do is register for the Karvy Online Investment Account, complete your e-KYC, enter the bank details, choose the investment, period of investment, and mode of investment (lump sum/SIP) and that’s all.
You can also choose from the list of top debt funds handpicked by the financial experts