Debt funds invest in fixed-income securities like treasury bills, commercial papers, corporate bonds, and government securities. These instruments have a set maturity date and offer a fixed interest rate payable upon maturity. Since market fluctuations do not influence the returns from debt funds, they are considered a low-risk investment option.
Each debt security is assigned a credit rating that helps investors assess the risk of the issuer defaulting on the repayment of principal and interest. Debt fund managers use these ratings to evaluate the quality of the debt instruments. A higher credit rating indicates a lower likelihood of the issuer defaulting on its financial obligations.
Yes, it is likely that Debt Mutual Funds may have invested in low-quality debt instruments. A low-quality debt instrument offers an opportunity to earn higher returns and the fund manager could decide to take a chance. However, a Debt Fund with high-quality instruments in the portfolio would have greater stability. A fund manager chooses long-term or short-term debt securities depending on whether the interest rates will likely rise or drop.
Debt Funds are ideal for risk-averse investors, offering stable returns by investing in diverse securities. While returns aren’t guaranteed, they typically fall within an expected range, making them suitable for cautious investors.
Given below is a classification of Debt Funds based on the maturity period:
These invest in money market instruments with a maturity of up to 91 days, offering higher returns than savings accounts, making them ideal for short-term investments.
Money Market Funds invest in instruments with a maturity of up to 1 year. They are suitable for investors seeking low-risk, short-term securities.
Dynamic Bond Funds adjust their investment in debt instruments of varying maturities based on interest rate fluctuations. Ideal for investors with moderate risk tolerance and a 3-5 year horizon.
At least 80% of these funds are invested in high-rated corporate bonds, making them a low-risk option for those seeking stable, high-quality corporate investments.
These funds allocate at least 80% of assets to debt securities issued by banks and public sector undertakings (PSUs), ensuring stability and safety.
Gilt Funds invest at least 80% of their corpus in government securities with different maturities. While they carry no credit risk, interest rate risk can be high.
These invest at least 65% of their corpus in corporate bonds with slightly lower credit ratings. They offer higher returns but carry increased risk.
Floater Funds invest at least 65% of their assets in debt instruments with floating interest rates, minimising interest rate risk.
These invest in securities maturing within a day, offering ultra-safe options with minimal credit and interest rate risks.
Investing in money market instruments and debt securities, these funds have a Macaulay duration of 3-6 months, providing a balance between short-term safety and returns.
There are also Medium Duration Funds (Macaulay duration 3-4 years), Medium to Long Duration Funds (4-7 years), and Long Duration Funds (over 7 years), catering to different investment horizons.
Debt Funds come with three main types of risks:
Returns of Debt Funds
Debt Funds offer lower returns than equity funds. Even the returns are not guaranteed. The NAV of Debt Funds varies with the rates of interest. The NAV of a Debt Fund is inversely proportional to the interest rates. It falls when rates of interest rise and vice-versa.
Expense Ratio
The expense ratio is what percentage of the Debt Fund’s total assets are diverted towards fees to manage the fund. Debt Funds don’t offer high returns; therefore, a high expense ratio could negatively impact your earnings.
What is your investment plan?
Debt Funds come with varying durations, ranging from as short as 1 day (Overnight Funds) to over 7 years (Long Duration Funds). Choosing the right fund depends on your financial goals and investment timeline. Many investors favour Debt Funds as a means to generate regular income.
Some investors divert a part of their portfolio towards a Debt Fund for reasons of stability.
Regardless of what your objective is, invest according to an investment plan.
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*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances.