What are debt funds – meaning, types & benefits.

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Looking to invest in mutual funds, but concerned about market volatility? You’re not alone. But, don’t let your hesitation hold you back from exploring mutual funds as an investment option. You can consider starting your journey with a relatively stable and low-risk option, such as a debt fund. Before we go deeper into what are debt mutual funds, let’s have a look at the various types of mutual funds:

Types of mutual funds

Some of the most common types of mutual funds are mentioned below:
• Equity funds
• Debt funds
• Hybrid funds
• Exchange traded funds
• Funds of Funds
• Solution-oriented funds

What is a debt fund?

A debt fund is a type of mutual fund that invests in fixed income generating securities such as bonds, treasury bills, government securities, and other money-market instruments. By investing in debt funds, investors can seek to generate a steady income for themselves, while also ensuring a level of relative stability to their investments.

Types of debt funds

Depending upon the investment objective and risk profile, debt funds are categorized into various types. Let’s have a quick look at some of the most common types of debt funds:

Overnight funds: Overnight funds are primarily low-risk-low-return investment proposition as they invest in overnight securities having a maturity period of 1 day. These funds provide liquidity and convenience and are suitable for investors looking to park funds for a short duration.

Liquid funds: Liquid funds invest in debt and money market instruments with a maturity of up to 91 days. These funds have relatively lower risk as compared to other debt funds and can seek to provide steady returns. Liquid funds are suitable for investors who wish to park surplus cash for a few days.

Money market funds: These funds invest in debt instruments with a maturity of up to one year and aim to generate returns.

Ultra-short duration funds: Investors with an investment horizon of at least 3 months can opt for these funds. These funds invest in relatively low-risk instruments and have the potential to earn slightly better returns than liquid funds.

Low duration funds: These funds may provide reasonable returns and are moderately risky. Investors with an investment horizon between 6 months and 1 year can consider opting for low duration funds.

Short duration funds: These funds invest in a variety of debt papers, corporate bonds, government securities, and other money market instruments. Short duration funds have the potential to earn higher returns than liquid and ultra-short duration funds, and are recommended for investment horizons of 1-3 years.

Medium duration funds: These funds invest in relatively high-yielding government securities, corporate bonds, etc. If you have a high risk appetite and an investment time horizon of 3 to 4 years, these funds may be suitable for you.

Medium to long duration funds: These funds invest in a variety of debt papers for relatively better returns. It is a moderate-to-high-risk investment proposition and has a portfolio duration of between 4 and 7 years. In case of rising interest rates, the risk may increase for these funds due to extreme volatility, but the returns may be limited.

Long duration funds: The portfolio duration is more than 7 years for long duration funds. In case of a rising interest rate, a long duration fund may expose its investors to high risk. Thus, it may not be suitable for investors, who are addressing their long-term financial goals.

Corporate bond funds: Corporate bond funds must invest at least 80% of the portfolio in higher-rated corporate bonds. Investors with low risk appetite who are looking for regular and steady income can opt for these funds.

Credit risk funds: These funds have the potential to generate higher yields as they invest a minimum of 65% of total assets in corporate bonds rated AA or below. Investors who can bear higher default risk may consider investing in credit-risk funds.

Banking and PSU funds: At least 80% of total assets are invested in debt instruments issued by PSUs, banks and other public financial institutions. These funds are usually moderate-risk investment propositions that aim to balance returns, safety, and liquidity.

Dynamic funds: Dynamic funds do not have any restrictions on security type or maturity profiles for investment. Dynamic funds manage their portfolios dynamically and flexibly as per the market situations.

Floater funds: Floater funds are debt funds that invest at least 65% of their portfolio in floating-rate bonds. These funds are considered relatively less risky since the floating rate securities are less susceptible to interest rate risk.
Now that you are aware of the various debt fund types, let’s have a look at some important benefits of debt mutual funds.

Benefits of debt funds

Relatively Steady income: Debt mutual funds can be considered a good investment option for conservative investors with low risk appetite. Also, since debt funds primarily generate income through fixed-income securities, they can offer relatively stable income to investors.

Liquidity: Unlike other conventional investments such as fixed deposits, investors can easily liquidate debt funds on any business day. This allows them to meet their urgent monetary requirement without much hassle.

Portfolio stability: While equity funds may generate better returns over the long term, the risk associated with them is relatively higher as compared to debt funds. By adding debt funds to your portfolio, you can diversify your investment and reduce the overall risk.
While it’s true that debt funds are relatively stable as compared to equity funds, you must carefully evaluate your risk appetite, investment horizon, and financial goals before investing in debt mutual funds. You can also consider seeking the help of a financial advisor to make an informed decision regarding your investments.


Is there any lock-in period for debt funds?

No, debt funds do not have any lock-in period and can be redeemed easily within 3 business days of placing the redemption request.

Who should invest in debt funds?

Debt funds usually carry relatively low risk. So, conservative investors with low risk appetite can consider investing in debt funds. Also, individuals who are new to the market can consider making debt funds a part of their portfolio before beginning to invest in equity funds. This can help them earn steady returns without being too concerned about market volatility.

Are debt funds risk-free?

Although debt funds are less risky than equity funds, they aren’t completely risk-free. As there are many types of debt funds, the level of risk depends on the average maturity of the specific portfolio.

How to invest in a debt fund?

You must evaluate your financial liabilities, investment horizon, risk appetite and financial goals to choose the right debt funds that suit your investment portfolio.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.