Just as you may have different outfits for different occasions, there are different mutual fund schemes for every goal and risk appetite. Like you would never wear your pyjamas to a party, you should also never invest in the wrong type of fund that does not match your purpose. Out of the many mutual funds, debt funds are said to carry the least amount of risk and are often recommended to investors with a low risk appetite. However, these, too, have further categorisations. Find out about the many types of debt funds so you can pick the right one for your needs.
First things first: What are debt funds?
Debt funds invest in fixed-income securities, such as commercial papers, corporate bonds, certificates of deposit, treasury bills, etc. They are also known as income or bond funds. The securities that debt funds invest in have a fixed maturity period and interest rate, which is why they are relatively low-risk investments.
Debt funds have a shorter maturity period than others, which is why they are highly liquid. They may also be more flexible and offer better growth potential than traditional options like fixed deposits and savings bank accounts.
In order to invest in debt funds, you must understand their types.
Types of debt funds
According to the Security and Exchange Board of India (SEBI), debt funds are divided into 16 types:
Overnight funds:
These funds invest in overnight securities with a maturity of up to one day.Liquid funds:
Liquid mutual funds invest in debt and money market securities with a maturity of up to 91 days.Ultra-short duration funds:
Ultra-short-term funds invest in debt and money market instruments such that the Macaulay Duration of the portfolio is between three and six months.Low duration funds:
These funds invest in debt and money market instruments with the Macaulay Duration of the portfolio between six and 12 months.Money market funds:
Money market funds invest in money market instruments with a maturity of up to one year.Short-duration funds:
These invest in debt and money market instruments such that the Macaulay Duration of the portfolio is between one and three years.Medium duration funds:
These invest in debt and money market instruments such that the portfolio’s Macaulay Duration is between three and four years.Medium to long-duration funds:
Medium to long-duration funds invest in debt and money market instruments such that the Macaulay Duration of the portfolio is between four and seven years.Long-duration funds:
These invest in debt and money market instruments such that the Macaulay Duration of the portfolio is over seven years.Dynamic bond funds:
The maturity period can differ for these funds depending on the interest rates.Corporate bond funds:
Corporate bond funds have a minimum investment of 80% in the highest-rated instruments of corporate bonds.Credit risk funds:
These funds have a minimum investment of 65% in below highest-rated instruments of corporate bonds.Banking and PSU funds:
They invest a minimum of 80% in debt instruments of banks, Public Sector Undertakings (PSUs), and public financial institutions.Gilt funds:
They invest a minimum of 80% in government securities with varying maturity periods.Gilt funds with a ten-year constant duration:
These invest a minimum of 80% in government securities such that the portfolio’s Macaulay Duration is 10 years.Floater funds:
They invest 65% of their total assets in floating rate instruments.
Read ‘Macaulay Duration’ a lot of times but not sure what it means? By definition, it is the time taken for the principal amount of a bond to be repaid from the internal cash flows generated by the bond.
But here’s an example that will help you understand it better.
Say, Bond X has a face value of Rs 2000 and a coupon rate of 8%. In this case, the annual interest payout will be Rs 160 (2000*8%). So, the Macaulay Duration of Bond X will be 12.5 years (2000/160).
Conclusion
Debt funds are useful for diversification and risk management. While they do carry some risk in the form of credit and interest rate risk, they can still be suitable for risk-averse investors and short-term goals. With a number of active and passive debt funds in the market, you can invest in any of them based on your unique investment needs.
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
