Debt Mutual Funds

How do Debt Funds work?

Each debt security has credit rating that helps investors assess likelihood that debt issuer won't be able to make principal & interest payments on time. These ratings are used by debt fund managers to identify high-quality debt products. higher rating suggests lower likelihood of default on part of issuer.

Different Types of Debt Mutual Funds

Debt funds can be categorized into following categories according on maturity period:

• Low term Fund: This fund makes investments in debt securities & money market instruments with Macaulay term of six to twelve months.
• Short Duration Fund: This fund makes investments in debt securities & money market instruments with one to three year Macaulay duration.
• Medium Duration Fund: This fund makes investments in debt securities & money market instruments with three- to four-year Macaulay duration.
• Medium to Long Term Fund: This fund allocates assets to debt securities & money market instruments with Macaulay term of four to seven years.
• Long Duration Fund: This fund makes investments in debt securities & money market instruments with longer than seven-year Macaulay duration.
• Liquid Fund: This fund makes investments in money market securities with maximum 91-day maturity. As alternative to savings accounts, liquid funds often provide higher returns on short-term investments.
• Money Market Fund: This type of investment focuses on money market securities with one-year maximum maturity. For investors looking for short-term, low-risk debt instruments, these funds are excellent fit.
• Dynamic Bond Fund: This fund makes investments in debt securities with different maturities according to interest rate regimes. Investors with three to five year investment horizon & moderate risk tolerance should consider these ETFs.
• Corporate Bond Fund: This fund allocates at least 80% of its total assets to highest-rated corporate bonds. If you want to buy premium corporate bonds but have lesser tolerance for risk, these funds are excellent option.
• Banking & PSU Fund: This fund allocates minimum of 808 percent of its total assets to debt securities issued by banks & PSUs (public sector undertakings).
• Gilt Funds: These funds allocate at least 80% of their investible corpus to government securities with range of maturities. Credit risk does not exist with these funds. interest rate risk is substantial, though.
• Credit Risk Fund: this fund allocates at least 65% of its investible corpus to corporate bonds rated lower than best available. As result, these funds have some credit risk but provide marginally higher returns than best-quality bonds.
• Floater Fund: This fund allocates at least 65% of its investible corpus to securities with floating rates. It is not risky to borrow money from these funds.
• Overnight Fund: This fund makes investments in debt instruments with one-day maturity. Because there is very little credit risk & interest rate risk, these funds are regarded as being incredibly safe.
• Ultra-Short Term Fund: This fund allocates assets to debt securities & money market instruments with Macaulay term of three to six months.
 

Who should invest in debt funds?

Investors wanting Consistent income

Risk-averse investors, such as retirees, seeking stable income, could consider debt funds that invest in high-quality bonds or maintain short durations. invest in debt mutual funds if you want regular income.

Investors who are conservative or new to mutual funds

Investors who are conservative or new to mutual funds & do not want to assume risk of investing in equity funds may wish to consider corporate bond funds or debt mutual funds as alternative to bank fixed deposits. debt fund investment is anticipated to yield higher returns in addition to liquidity & withdrawal flexibility, particularly in dropping interest rate environment.

Investors seeking to buy stocks during bear market

Combining debt fund & Systematic Transfer Plan (STP) can help even most aggressive stock investor. Investors who want to park short-term funds can deploy short-term surpluses in liquid or ultra-short duration funds rather than leaving them in bank deposit; overnight or liquid fund can even hold household emergency funds while earning modest return; investors with specific investment horizon can opt for FMP.

Investors wishing to park short-term funds

Rather than putting short-term surpluses in bank account, households & businesses can use them in liquid or ultra-short duration funds. Even household emergency money can be held in overnight or liquid fund & generate small return. FMP is option for investors who have set investment horizon.
 

Things to consider before investing

Although debt funds are among least hazardous mutual funds, investors should remember that they are still products of market, just like all other mutual funds. Even top-performing debt funds are subject to interest rate & credit risk, & returns cannot be guaranteed. Fund managers have minimal control over market interest rates, which determine interest rate risk. Months' worth of capital gains might be lost by unanticipated rate increase, particularly for long-duration fund.

The probability of principal & interest payment default by bonds held by debt fund gives rise to credit risk. It is evident from IL&FS downgrading & ensuing value erosion for certain debt funds that even liquid assets are susceptible to negative effects of credit default. By closely examining fund's specifications, choosing top-performing funds with track record, & ensuring that their expectations for risk & return match debt fund's investing goal, investors can reduce risk.

Taxation for Debt Funds

Debt mutual funds taxation is in such manner that Debt funds provide investors possibility of capital gains & income. difference between purchase price & redemption or sale price of units is known as capital gain.
The period of time investor owns units in mutual fund determines how capital gains are taxed. Capital gains on redemption or sale are regarded as short-term capital gains & are subject to taxation at investor's appropriate income tax slab rate if investor remains invested in debt fund for maximum of three years.