KNOWLEDGE CENTRE Debt Funds / What Are Debt Funds And Their Types?

What Are Debt Funds And Their Types?

Debt mutual funds are generally a mixture of debt or fixed income securities like Government Securities, Treasury Bills, Corporate Bonds, other money market instruments and debt securities of different maturities. Debt Mutual Funds invest in bonds that are assigned credit ratings which show the ability of the issuer to pay back the debt over a period. The credit ratings are issued by companies like CRISIL, CARE, FITCH and ICRA.

The debt funds are also differentiated based on the instrument they choose to invest in, such as if their maturity period is longer than one year, they are called debentures or bonds. However, if the maturity period is shorter than a year then they are introduced as commercial papers or treasury bills. The borrower/issuer of these bonds securities are legally bound to pay the principal along with interest at the end of the agreed upon period.

These funds have a presentation value on which the rate of interest is calculated. Usually, an investor who desires to invest in this fund is concerned with the interest rate, face value, maturity value, and period. On an average, these funds are held until maturity, unlike other mutual funds that see a lot of attrition.

What Are The Different Types Of Debt Funds?

There are many types of debt funds that cater to the different investment needs you might have. Listed below are some of the most common types of debt funds:

  1. Gilt Funds

  2. Ultra-Short Term Funds

  3. Fixed Income Funds

  4. Fixed Maturity Funds

  5. Liquid Funds

Let’s learn more about the above mentioned debt funds:

Gilt Funds

These funds invest in all government debt like bonds issued by Central Bank on behalf of the government. This also includes the ones issued by the state government. The investment is done on paper hence they carry zero default risk. But, the interest rate can remain a cause of concern. In fact, long-term gilt funds are the riskiest funds as they are sensitive to interest rate charges.

Ultra-Short Term funds

The investment is done in debt securities like commercial papers, certificate of deposits etc. It has a maturity of 3-6 months and is not affected by changes in interest rates. Hence, the returns of ultra-short term debt funds are consistent.

Fixed Income funds

The fixed income funds are invested in corpus across debt instruments like bonds, government securities, and corporate debentures. They can also invest in maturity profiles like 1-2 years’ time frame and even 15-20 years.

Fixed Maturity Funds

The fixed maturity funds have a fixed tenure. They invest in papers with matching maturity and are held until then. Hence, they take away the interest rate risk. Even if the interest rate moves up, NAV is not affected.

Liquid funds

The liquid funds invest in liquid money market instruments like inter-bank call money market, treasury bills, commercial papers and certificate of deposits. The returns on liquid funds are most suitable as compared to others. Since they provide easy liquidity, it is a good substitute of savings banks account.

What Is The Difference Between Debt Funds, FDs, and RDs?

Both debt mutual funds and fixed deposits are a good option for the cautious investor. Here are five points that mention the advantages of debt funds over fixed deposits:

  • In FDs or RD, TDS is applicable if interest income exceeds ?10,000 per year. However, TDS is not applicable on debt mutual funds.

  • The debt mutual funds can be set off against short or long term capital losses from your other investments.

  • The debt funds can give better returns than savings banks accounts and bank deposits.

  • Safety of your investments is similar in both debt mutual funds and FDs.

  • Debt funds can also be considered for investment during the retirement phase using Systematic Withdrawal Plans (SWPs).

How To Choose The Right Debt Fund For Your Needs?

Choosing a debt mutual fund should be based on two factors, the investment horizon and the scheme matching it. This will help remove all the major confusions. Here are some of the major reasons why you should choose to invest in debt mutual funds:

  1. Duration Of Investment Period

  2. High Quality Profile

  3. Lesser Exposure To Risks

Now let’s look at the above mentioned points in greater detail:

  • Duration Of Investment Period

Debt mutual funds specify the investment time frame. There are debt funds specially designed to be invested in for the short term, medium term, and long term. The instruments that these funds invest in are chosen according to the returns that they offer while keeping the risks involved in check.

  • High Quality Credit Profile

The debt mutual funds should focus on highest credit quality exposure. Globally, only the highest quality credits such as A1P1 are eligible for liquid funds. These ratings represent long-term ratings of up to A or at best A- on the global rating scale.

  • Lesser Exposure To Risks

The debt mutual funds are exposed only to the risk of interest rate fluctuations which affect the prices of underlying bonds in the fund portfolio. Since the interest rates don’t fluctuate much, investments in debt funds are considered to be much safer than equity funds.

What Are Benefits Of Investing In Debt Mutual Funds?

Mentioned below are some of the prime benefits of investing in debt funds:

  1. No Loss On Day’s Growth

  2. Higher Returns and Tax Benefits

  3. Flexibility

Let’s look at the benefits in more detail:

  • No Loss on Day’s growth

With investments in mutual funds, the investors do not lose even a day’s growth. The investment does not stop growing until you redeem it.

  • Higher Returns and Tax benefits

The pre-tax returns from debt funds are comparable with those with other debt options. But if the interest rate changes, the debt fund could give higher returns.

  • Flexibility

Certain types of debt funds such as liquid funds are more flexible than fixed deposits. The amount can be withdrawn each month which is especially good for retired people. Additionally, one can shift the money from debt fund to equity fund or any other scheme.

Debt funds are one of the best instruments if you want higher returns than traditional instruments such as fixed deposits and recurring deposits, but don’t want to expose your money to the higher risks and volatility of the share market. You can also use Angel Bee’s ARQ Mutual Fund Investment Engine that helps you pick the right debt fund for your needs.

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