Debt Funds: Definition
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.
Benefits of Investing in Debt Mutual funds
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.
Debt 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 The amount can be withdrawn each month which is especially good for retired people.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.
Types of Debt 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.
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 profile is consistent.
The 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.
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.
Debt Mutual Funds v/s Fixed Deposits or Recurring Deposits
How to choose Debt mutual funds?
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.
The Debt mutual funds specify the investment time frame which the investors sometimes overlook. They remain invested for many years without keeping the market factors in mind.
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.
Consider the risks involved
The Debt mutual funds are exposed to the risk of interest rate fluctuations which affect the prices of underlying bonds in the fund portfolio. The investor also under the risk of credit and liquidity risks as not many people invest in debt funds.