Debt Funds - Meaning, Types, Benefits and Returns

Debt Fund

A mutual fund scheme which invests in fixed income instruments are named as Debt fund, for example money market instruments, corporate debt securities etc. which offer appreciation in the capital. These are also named as bond funds or fixed income funds. Debt funds offer many advantages such as low-cost structure, reasonable safety, relatively high liquidity. These are beneficial for investors who want regular income and less of risk. Debt funds are less risky than equity funds. Debt funds can be a good option if you which to have steady returns with low volatility because these are more tax efficient.

Debt Funds Working 

Based on the credit ratings debt funds invest in a variety of securities, as the credit ratings help understand the risk of default in disbursing the returns the instrument issuer had promised. Debt fund manager will always ensure to invest in high rated credit instruments, which means the entity will pay interest on the debt security regularly and is likely to pay back the principal upon maturity. 

If compared to low rate securities Debt Funds which invest in high rated securities are less volatile. In addition to it maturity is also dependent on the overall interest rate and investment strategy of the fund manager. If the interest rate regime is falling, it will encourage the fund manager to invest in long term securities. On the contrary rising interest rates will make him invest in short term securities. .

Debt Funds Investment

Debt funds invest across all classes of securities hence optimizing returns which allow debt funds to earn good decent returns. Although, the returns are not guaranteed. The returns of debt funds majorly fall in a very predictable range which makes them safer for the investors who are more conservative. These are also workable for both short term and medium-term investors. Short term ranges and medium-term ranges are three months to one year and three years to five years respectively 

a. Short-Term Debt Funds

Debt funds such as liquid funds may be an ideal investment for a short term investor compared to just keeping money in their accounts. Liquid funds majorly offer higher returns which range from 7%-9% along with similar liquidity kinds to meet the emergency requirements.

b. Medium-Term Debt Funds

Debt funds like dynamic bond funds are ideal for a medium-term investor. Debt funds offer higher returns when compared to a 5-year bank fixed deposit. Monthly income plans will be a good option in case you wish to have regular income from your investments.

Types of Debt Funds

Suiting the diversity of investors, debt funds are of various types. The basic difference between debt funds is the maturity period that they invest in the instruments. Here below the different types of debt funds

a. Dynamic Bond Funds

When the fund manager keeps changing portfolio composition based on the fluctuating interest rate regime, the funds are named as dynamic funds.  These funds take different interest rate calls and invest in instruments of both longer and shorter maturities hence they have different average maturity periods. 

b. Income Funds

Income funds are more stable than dynamic funds because these predominantly invest in debt securities with extended maturities. Income funds offer maturity of income funds for around five to six years.

c. Short-Term and Ultra Short-Term Debt Funds

Debt funds which invest in instruments with shorter maturities are named as a short term of ultra short term debt funds. The maturity ranges from one year to three years. These funds are not affected much by interest rate movements hence these are good for conservative investors. 

d. Liquid Funds

The funds which invest in debt instruments with a maturity of precisely 91 days making them completely risk-free are named as liquid funds. There are rarely any negative returns in liquid funds. They provide similar liquidity with higher yields to that of a savings bank account. There are mutual fund companies which offer instant redemption of liquid funds through unique debit cards.

e. Gilt Funds

The funds which invest only in government securities having high rated securities with very low credit risk are named as Gilt funds. The loan it takes in form of debt instruments are seldom default by the government, guilt funds are an ideal choice for conservative and risk-averse investors.

f. Credit Opportunities Funds

Credit opportunities funds are relatively newer debt funds and unlike other debt funds these funds try to earn higher returns by holding lower-rated bonds or by taking a call on credit risks. Credit opportunities funds are riskier debt funds compared to others and unlike other debt funds they do not invest as per the maturities. 

g. Fixed Maturity Plans

Closed-ended debt funds are called fixed maturity plans (FMP). Fixed maturity plans invest majorly in fixed income securities like government securities and corporate bonds. There will be a fixed horizon in fixed maturity plans for which your money will be locked. The tenure may vary from months to years. Although the investment can be made only during the initial offer period. It is very similar to a fixed deposit that does not guarantee higher returns but delivers superior tax-efficient returns.

Debt securities and investment in debt funds is a regular feature of mutual fund investments that focus on stable return options along with planning for a longer term period. Therefore, when it comes to debt based instruments, it must be kept in mind that options that yield significant incomes are the best suited for you. In any case, mutual fund investment offers credible scope for diversification of the portfolio. The fund managers know the market options that favour a balanced investment scheme for your comprehensive benefits. These benefits that are accrued may be in the shape of periodic payouts or lump sum benefits, as per the pre-decided terms and conditions.  

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