Fixed Income Mutual Funds: Meaning, Benefits, Risks & Types

What is Fixed Income Mutual Funds?

Fixed income mutual funds are mutual fund schemes that invest primarily in debt securities and money market instruments. These may include government securities, corporate bonds, treasury bills, commercial papers, certificates of deposit, and other fixed-income instruments.

The securities held by the fund generally make interest payments according to their terms. However, the return received by investors depends on the overall performance of the fund. Changes in interest rates, credit quality, market prices, portfolio duration, and fund expenses may affect the value of the investment.

Investors receive mutual fund units based on the amount invested and the applicable Net Asset Value (NAV). The NAV changes according to movements in the value of the underlying securities. Therefore, fixed income mutual funds do not provide fixed or assured returns.
 

Why Invest in Fixed Income Mutual Funds in India?

The following are some features associated with fixed income mutual funds:

• Professional Fund Management: Fund managers select and manage debt securities according to the investment objective and portfolio strategy of the scheme.
• Portfolio Diversification: A scheme may invest across multiple issuers and fixed-income instruments. The level of diversification depends on the fund category and portfolio approach.
• Different Fund Categories: Investors can access funds with different portfolio durations, credit profiles, and investment strategies.
• Access to Debt Markets: These funds provide exposure to debt securities through a mutual fund structure. Some of these securities may have higher direct investment requirements.
• Liquidity: Many open-ended schemes allow investors to purchase and redeem units on business days. However, exit loads and other scheme conditions may apply.
• Systematic Investment Plans: Some fixed income mutual funds allow investments through a Systematic Investment Plan (SIP), subject to the scheme’s terms and minimum investment requirements.
   

Risks Associated with Fixed Income Mutual Funds

The following are some risks associated with fixed income mutual funds:

• Interest Rate Risk: Bond prices generally move in the opposite direction to interest rates. When interest rates rise, the market value of existing debt securities may decline.
• Credit Risk: An issuer may face difficulty in making interest or principal payments. A change in the issuer’s credit quality may also affect the value of the security.
• Liquidity Risk: Certain securities may be difficult to sell quickly at the expected market price. This may affect the value of the portfolio during some market conditions.
• Duration Risk: Funds holding securities with longer durations may experience greater changes in NAV when interest rates move.
• Market Risk: Economic conditions, government policies, market liquidity, and changes in interest rates may influence the value of the portfolio.
• Capital Loss Risk: The NAV of a fixed income mutual fund may decline. Therefore, the invested amount is subject to market-related losses.

The level of risk depends on the fund category, portfolio duration, credit profile, and underlying securities.

Factors to Consider Before Investing

The following factors may be reviewed before evaluating fixed income mutual funds:

• Investment Objective: The scheme objective explains the type of securities in which the fund may invest and the approach followed by the fund manager.
• Portfolio Duration: Duration indicates the sensitivity of a debt portfolio to interest rate changes. A longer-duration portfolio may experience greater changes in NAV.
• Credit Quality: Credit ratings provide information about the credit-related risk associated with an issuer. Ratings may change and do not remove investment risk.
• Expense Ratio: The expense ratio represents the costs charged for managing the scheme. These expenses are reflected in the NAV.
• Exit Load and Liquidity: Some schemes may charge an exit load when units are redeemed within a specified period. Redemption terms may also vary.
• Portfolio Composition: Investors may review the securities held, issuer exposure, maturity profile, and credit quality of the portfolio.
• Risk Level and Tax Treatment: The Riskometer provides information about the scheme’s risk level. Tax treatment depends on applicable tax provisions and may change over time.
   

Types of Fixed Income Mutual Funds

Individuals exploring the best fixed income mutual funds India may benefit from understanding the different types of funds available. The following are some common types of fixed income mutual funds in India:

Overnight Funds

Overnight funds invest in securities with a maturity of one day. Their portfolio duration is generally very short.

Liquid and Money Market Funds

Liquid funds invest in debt and money market instruments with a maturity of up to 91 days. Money market funds invest in money market instruments with a maturity of up to one year.

Corporate Bond Funds

Corporate bond funds invest mainly in corporate debt securities. Their portfolios are generally required to maintain a specified allocation to higher-rated corporate bonds under the applicable category framework.

Banking and Public Sector Undertaking Funds

These funds invest mainly in debt securities issued by banks, public sector undertakings, and public financial institutions.

Gilt Funds

Gilt funds invest in government securities. They may have lower credit risk related to government-backed securities. However, interest rate movements may affect their NAV, particularly when the portfolio duration is longer.

Dynamic Bond Funds

Dynamic bond funds may change their portfolio duration based on the fund manager’s view of interest rate movements. Therefore, the duration and interest rate exposure may vary over time.

Credit Risk Funds

Credit risk funds may hold a higher allocation to lower-rated corporate debt securities. Their credit-related risk may be higher than that of funds focused mainly on higher-rated securities.
 

Fixed Income Mutual Funds vs. Fixed Deposits

The following table highlights some of the key differences between fixed income mutual funds and fixed deposits:

Who Should Invest in Fixed Income Mutual Funds?

The relevance of a particular fund depends on the investor’s financial objectives, investment period, risk considerations, and liquidity requirements. The following are some situations in which investors may evaluate fixed income mutual funds:

• Investors Seeking Debt Market Exposure: These funds provide exposure to government securities, corporate bonds, and money market instruments through a mutual fund structure.
• Investors Reviewing Different Duration Options: Fixed income mutual funds are available across short-duration, medium-duration, and longer-duration categories.
• Investors Considering Portfolio Diversification: Debt-oriented mutual funds may be reviewed as one component of a portfolio that includes different asset classes.
• Investors Looking for Professionally Managed Portfolios: The securities are selected and monitored by fund managers according to the scheme objective.
• Investors Considering Periodic Investments: Some schemes allow investments through a Systematic Investment Plan (SIP), subject to scheme availability and applicable terms.
• Investors With Defined Liquidity Requirements: Open-ended schemes generally allow redemptions on business days. However, exit loads, settlement periods, and other conditions may apply.
   

Conclusion

Fixed income mutual funds primarily allocate their investments in debt instruments and money market instruments. The performance of fixed income mutual funds could be affected by several factors such as interest rates, credit risks, maturity period of the fund's portfolio, market situations, and related costs. Different classes of fixed income funds use different investment strategies and may involve differing degrees of interest rate risk and credit risk. Fixed income funds also have differences in comparison to fixed deposits regarding returns, market exposure, liquidity, and taxes. Investors may consider the scheme's objectives, composition of the portfolio, maturity period, credit rating, costs, and related taxes prior to evaluating a fund. Understanding these factors can provide a clearer view of how fixed income mutual funds operate.