Understanding Debt Funds

Debt funds are preferred by individuals who are not willing to invest in a highly volatile equity market. A debt fund provides a steady but low income relative to equity. It is comparatively less volatile.  Below is a guide to how debt funds are classified:

Liquid Fund:

Liquid funds are debt mutual funds that invest your money in very short-term market instruments such as treasury bills, government securities and call money.

These funds can invest in instruments up to a maturity of 91 days liquid funds are used by investors to park their money for short periods of time typically 1 day to 3 months.

For example, if you have your child’s school fee installment or a holiday planned over the next two months, you could park the money in a liquid fund.

Ultra-Short Term Fund:

Ultra short-term bond funds are close cousins of liquid funds but some can be vastly different. Unlike Securities and Exchange Board of India’s (SEBI) rules for liquid funds, that they can only invest in securities that mature up to 91 days but ultra-short term bond funds have no such rule.

UST funds are very short-term debt funds that seek to invest in a combination of certificates of deposits, treasury bills, commercial papers as well as corporate bonds with average maturity that range from 91  days to 18 months.

But these are one notch higher on the risk chart compared with liquid funds. These instruments may also be traded in the market. Hence, the NAV may swing in response to market movements, making it a little more volatile.  If you wish to park your cash for 1-9 months, then this one is for you.

 Short Term Fund:

A short-term fund is a type of Mutual fund that invests in short-term investments of high quality. A short-term debt fund comes with a reasonable amount of risk and aims to give relatively stable returns. It is like an alternative for your fixed deposits (FDs) of equivalent tenures. However, if you hold a short-term debt fund for at least three years, it becomes more tax-efficient than a Fixed Deposit, though the funds are also riskier.

Long Term Fund:

These funds comprise of investments made in a basket of debt instruments of different maturities & issuers. These funds are suitable for investors who are willing to take a relatively higher risk as compared to corporate bond funds, and have longer investment horizon. If entry and exit are timed properly these funds give great returns. Investors can consider entering these funds when interest rates go up to benefit from higher accrual and when the outlook is that interest rates would go down. As interest rates go down, investors can reap benefits from capital gains as well.

Gilt Fund:

Gilt Funds invest in government securities of medium and long term maturities issued by Central and State governments. Since, the issuer is the Government the chances of default is very low or zero. Net Asset Values (NAVs) of the schemes fluctuate due to change in interest rates and other economic factors. These funds have a high degree of interest rate risk, depending on their maturity profile. The higher the maturity profiles of the instrument, higher the interest rate risk.

Fixed Maturity Plans (FMP):

Fixed Maturity Plans (FMPs) are closed ended Debt Mutual Funds that invest in debt instruments with a specific date of maturity that is less than or equal to the maturity date of the scheme. They are closed-ended in nature, which means that once the NFO (new fund offer) closes, the scheme cannot accept any further investment.

Securities are redeemed on or before maturity and proceeds are paid to the investors. FMPs are similar to passive debt funds, where the portfolio manager buys and holds the debt securities for the entire duration of the product. FMPs are a good option for conservative investors, as they do not carry any interest rate risk provided the investor stays invested until the maturity of the product. They are also a tax efficient investment option.

Corporate Bond Fund:

These funds invest predominantly in corporate bonds and debentures of varying maturities that offer relatively higher interest, and are exposed to higher volatility and credit risk. They seek to provide regular income and growth and are suitable for investors with a moderate risk appetite with a medium to long term investment horizon.

Corporate bonds have the following advantages:

  • They have higher growth potential than government bonds
  • They are less vulnerable to inflation and interest rate increases than government bonds due to generally shorter periods to redemption
  • They are a very useful diversifier for low-medium, medium and medium-high risk portfolios
  • They are less risky than equities or property

Monthly Income Plan (MIP):

Monthly Income Plans (MIPs), strive to offer the benefit of diversification across asset classes by investing a proportion of the portfolio in debt securities (70% to 95%) with a smaller allocation in equity securities (5 % to 30 %).

A Monthly Income Plan (MIP) is a type of mutual fund scheme that invests in debt and equity securities. An MIP aims to provide a steady stream of income in the form of dividend payments.

As the correlation between prices of equity and debt is low, this product endeavors to give an investor returns that are relatively higher than debt market returns. They can be classified as debt oriented hybrids that seek to; generate income from the debt securities, maximize the benefits of long term growth from equity securities and aim for periodic distribution of dividends.

It is typically attractive to retired persons or senior citizens without other substantial sources of monthly income. Available to most investors. MIPs are in frequent use for investors an India.

That’s all about your guide to Debt Funds…

Happy Investing! Contributed by Divya Syontri from Moat Wealth Relationship Management Team

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