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Debt funds are mutual funds that invest a significant part of your money into securitised debt like bonds and money market instruments. These funds are also termed as fixed-income funds because securitized debt typically features a fixed rate of return. Investing in a debt instrument is like lending money to all the entities issuing the instrument. The issuers of debt instruments decide the interest rate and the maturity period well in advance. Hence, debt funds are also known as 'fixed-income' securities.
Now that you know what are debt funds and debt funds meaning, you must know the types:
As per the rules of SEBI, the debt mutual funds are categorised based on the weighted average time taken to generate the cash flow till maturity. Keep scrolling through to learn the different types of debt funds:
As per the guidelines of SEBI, overnight funds are all those that invest in assets that mature in just one day. These funds are short-duration funds. This type of mutual fund invests in money market instruments and repurchase agreements, commonly known as REPO.
As per SEBI rules, liquid funds are considered the most suitable funds for short-term investment. This instrument has a maturity period of up to 91 days. Liquid funds are considered an ideal option as the shorter term implies that they are less prone to economic downturns. The instruments of liquid short-term debt funds include commercial papers, T-bills (Treasury Bills) and government securities.
These are open-ended mutual funds that invest with a maturity period of 3 to 6 months. They include certificates of deposits, bonds and T-Bills.
As per SEBI guidelines, low-duration funds are open-ended debt mutual funds which invest in securities with an average maturity of 6-12 months.
These debt funds usually invest in instruments with average residual maturity ranging between 1-3 years. The short-term debt funds invest in short-term corporate bonds, along with other government and money market instruments.
These mutual funds make debt investments that have an average maturity of 3-4 years. The medium-duration funds invest in a mix of corporate debt instruments and bonds, government and money market securities.
Unlike the other funds, medium to long-duration funds are ideal options for all those who are looking for a long-term investment with more risk appetite. As per SEBI guidelines, their investments have a maturity period of 4 to 7 years. It includes corporate debt and government securities.
These debt funds have the longest Macaulay duration of seven years or longer, which makes these mutual funds the most prone to duration risk. To mitigate this risk, investors need to stay invested in these schemes for a longer duration.
Debt funds offer numerous advantages to investors. Some of them are listed below:
Investing in debt funds gives you the advantage of adding to your investments through interest earnings as well as capital gains. In addition, it allows the investor to access the money market in which they cannot invest directly.
Debt Funds can help diversify your investment portfolio which can help reduce the risk and reduce overall risk an investment portfolio. This occurs due to the relatively low correlation between debt and equity markets. Due to the comparatively lower volatility of debt markets compared to equity markets, the Net Asset Value (NAV) of a debt fund typically does not go through major ups and downs.
Debt funds have a spectrum of maturity and credit risk. Schemes like ultra-short duration and short duration funds help in generating regular and stable income. At the same time, longer-duration funds have the opportunity to generate higher interest income in the short-term and capital gains in the longer term.
Debt funds are very liquid funds and can be redeemed easily within a short period of placing the redemption request. Also, there is no lock-in period, and there are no penalties involved in withdrawing the fund invested.
As per SEBI, the total expense ratio (TER) of a debt fund cannot exceed 2%. Liquid funds and overnight funds come with very low expense ratios. This has the potential of increasing the overall gains that an investor can receive.
No investment is completely without risk and the same is true for Debt Funds. This is the case even though debt funds are less volatile as compared equity investments, especially in the short term. Below are the key risks you need to consider before making debt fund investments:
Since Debt Funds primarily invest in bonds and other fixed-return instruments, they offer a fixed rate of return in the form of coupon rate. So, changes in market rates like repo and reverse-repo can impact the returns offered by debt funds. This is the basis of interest rate risk in the case of Debt Funds.
As a rule of thumb, when market interest rates increase, bond prices decrease and when market interest rates decrease, bond prices increase. An increase in bond prices increases the return from debt funds, while decrease in bond prices leads to a decline in debt fund returns. The interest rate risk of a debt fund is measured using modified duration of the scheme. Higher modified duration means higher risk, while lower modified duration means lower risk to the investor.
The key reason for credit risk in Debt Funds is linked to the quality of investments that the scheme makes. Lower quality bonds and money market instruments are considered to be of higher risk that higher quality debt instruments like Government securities (G-Secs) and Treasury Bills (T-Bills). However, higher quality debt instruments typically offer lower coupon-rates as compared to relatively lower quality debt investment. This can impact returns that the investor can receive. Credit risk in this case relates to the possibility that low-quality investments of a debt fund might default on its coupon payments and impact the overall returns of the scheme.
If you wonder whether short-term debt funds are the right choice for you or not, then you should not worry. These funds have something for every investor whether they plan to make lump sum investments or via Systematic Investment Plan (SIP). Here is the list of investors who can park their funds in debt to earn low to moderate returns.
Investing in debt funds is a simple and hassle-free process, which involves some easy steps. Keep scrolling through to learn how to invest in debt funds:
To choose the best debt fund to park your surplus money, it is extremely crucial to take into account various factors, like risk, returns, fees, the maturity period of the funds, and tax on mutual funds. Select the best fund for yourself on the basis of your risk appetite and investment horizon.
ARN No: Nov22/Bg/10D
Disclaimer:
The investment risk in Investment portfolio is borne by the policyholder.
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