Getting to Know Debt Funds

The ideal investment portfolio must balance risk and reward, with a mix of investment tools chosen according to the individual’s objectives, time horizon and risk appetite. 
Apr 2023
3 mins read
The ideal investment portfolio must balance risk and reward, with a mix of investment tools chosen according to the individual’s objectives, time horizon and risk appetite. One category of tools popular with more cautious investors is debt funds. These are relatively low-risk mutual fund investments that could help you earn moderate returns over a shorter period.
Debt funds are also known as fixed income or bond funds. They’re mutual fund schemes that invest in fixed income instruments, which include corporate debt securities, treasury bills and government bonds, offering investors income as well as possible capital appreciation.
Debt funds might be ideal if, for instance, you want to create an emergency fund, or give your car a full servicing in a few years. They are also suitable for investors who are cautious or sceptical about stock market performance, as they offer stable returns while minimising the risk of market volatility.

Know the 16 types of debt funds
  1. Overnight Funds – These funds invest in fixed income instruments with a duration of one day, and aim to provide liquidity to investors at the prevailing yield levels. Their convenience makes them suitable for corporate treasuries and other investors looking to park their funds for a very short duration.
  2. Liquid Funds – As the name suggests, these funds offer liquidity. The underlying assets of the fund have a short maturity duration, typically less than 90 days. They are suitable for corporates and individuals looking to build an emergency corpus. Their primary aim is to negate volatility and provide higher liquidity to its investors.
  3. Ultra-Short Funds – These funds suit investors looking to park their money for 3-6 months. They invest in a mix of debt securities and money market instruments and leave you well-placed to meet specific cash outflow requirements after a few months. 
  4. Low Duration Funds – These funds cater to investors looking to invest cash for 6-12 months and avail of potentially higher returns than ultra-short funds.  
  5. Money Market Funds – These funds have an investment horizon not exceeding one year, and aim to provide returns through interest income and potential capital appreciation.
  6. Short Duration Funds – These funds invest in multiple securities to maximize returns, and come with a maturity period of 1-3 years.
  7. Medium Duration Funds – These funds have a maturity period of 3-4 years and invest in a mix of government, public and private sector bonds for optimum returns and safety of capital.
  8. Medium to Long Duration Funds – These funds have an investment horizon of 4-7 years and aim to optimise returns for investors by investing in an array of corporate and government bonds.  
  9. Long Duration Funds – The investment horizon on this category of fund exceeds seven years. Given this long horizon, they invest in long maturity debt which has the potential to offer substantial returns to investors.
  10. Dynamic Bond Funds – This is a versatile category with no restrictions on security type or maturity horizon for parking funds. Funds here are dynamically managed, and the fund managers will realign the weights and securities depending on market situations.
  11. Corporate Bond Funds – These funds invest over 80% of their capital in the most secure corporate bonds, rated AA+ or higher.  
  12. Credit Risk Funds – These funds invest at least 65% of their capital in corporate bonds rated below AA+, offering both higher risk and reward for investors when compared to corporate bond funds.  
  13. Banking and PSU Funds – These debt mutual funds invest a minimum of 80% of their total assets in bank, PSU and public financial institutions’ papers. They aim to maximise returns while minimising liquidity and risk.
  14. Gilt Funds – This is a category of highly secure funds that invest in government securities with varying maturity periods.
  15. Gilt with 10 Year Constant Duration Funds – These funds offer a consistent portfolio duration of 10 years, investing a minimum of 80% of their total assets in government securities.
  16. Floater Funds – Funds in this category invest at least 65% of their total assets in floating-rate bonds. The rates of underlying assets are reset periodically.

The advantages of debt funds

  • They are less risky than equity investments and thus help investors minimise their portfolio risk.
  • They are suitable for short-term deployment, offering stable returns compared to other assets like equities.
  • They allow retail investors to access instruments not directly available for subscription.
  • They make for a low-cost investment, as they do not usually come with an exit load and SEBI has capped their TER at 2%***.
  • They offer varying investment horizons catering to different needs.

Debt funds are a less volatile investment option than equity funds and could provide a steady source of secondary income. Their precise level of risk and return depends on the nature of the individual fund. Consult a financial advisor who will help you choose the fund that’s right for you. 

Disclaimer: Mutual fund investments are subject to market risks, read all scheme-related documents carefully.

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