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What are Debt Mutual Funds?

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Debt funds are mutual fund schemes which invest in fixed income generating securities such as Commercial Papers (CP), Certificate of Deposit (CD), Corporate Bonds, T-Bills, government securities and other money market instruments. These instruments have a fixed maturity date and interest rate that the buyers could earn till the maturity of the security. They are considered to be less volatile than equity funds and are hence ideal for investors who are relatively risk averse and are looking for stability in their investments.

  • long-term potential

    Investments in debt fund have the potential to generate better returns than traditional investment avenues

  • expo-stock-market

    Less volatile than equity funds

  • long-term goals

    Ideal for short term to medium term investing

Types of Debt Funds

There are different types of debt mutual funds available for investors to choose from based on the maturity period, risk profile and investment objective of the investor.

Overnight Fund

This fund invests in securities which have a maturity period of 1 day. Overnight Fund carry minimal credit risk and interest rate risk owing to such a short maturity period and are hence perceived to be relatively stable.

Liquid Fund

Liquid Fund invests in debt and money market securities with residual maturity upto 91 days only. The underlying instruments are fairly liquid and have the potential to offer reasonable returns than traditional avenues. Some liquid funds also have the option of instant redemption facility which allows redemptions upto ₹50,000 per day per scheme per investor.

Ultra-Short Duration Fund

Ultra-Short Duration Fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 3-6 months.

Low Duration Fund

Low Duration fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 6-12 months.

Money Market Fund

Money Market Fund invests in money market securities with a maximum maturity of 1 year. This fund is a good alternative to park surplus money for short term. It can also be used as an emergency fund as it is relatively highly liquid and has the potential to generate better returns than traditional avenues.

Short Duration Fund

Short Duration Fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 1-3 years.

Medium Duration Fund

Medium Duration Fund invests in debt securities and money market instruments such that the Macaulay Duration of the portfolio is between 3-4 years.

Corporate Bond Fund

Corporate Bond Fund predominantly invests in corporate bonds rated AA+ and above. It is a good option for investors having a moderate risk appetite who want to invest in papers having relatively lower credit risk.

Credit Risk Fund

This fund predominantly invests in papers rated AA and below (excluding AA+ rated corporate bonds). Credit Risk Fund aims to earn higher returns by investing in papers which offer relatively higher interest rates. However, they carry credit risk compared to other debt funds.

Banking & PSU Fund

Banking & PSU Fund invests at least 80% of its assets in debt and money market securities of Banks, PSU (Public Sector Undertakings), Public Financial Institutions and Municipal Bodies.

Dynamic Bond Fund

Dynamic Bond Funds invest in debt instruments having varying maturity based on the current interest rates. The fund manager changes the portfolio dynamically depending on the interest rates. These funds are a good option for investors having a slightly moderate risk tolerance and are looking to earn regular income for medium term.

Gilt Funds

Gilt funds invest at least 80% of its assets in government securities with varying maturities. They are considered relatively one of the stable investments as given the exposure to sovereign papers, there is very little credit risk. This makes gilt funds a good choice for risk averse investors.

Note - Macaulay Duration is the weighted average time to receive the cash flows from a bond. It measures the time an investor would take to get his invested money in the bond by way of periodic interest as well as principal repayments. It is usually measured in years.

View Debt Mutual Funds

Benefits of debt funds - Why invest in Debt Funds?

  • first-beefit
    Liquidity

    Unlike traditional avenues, debt funds don’t have a lock-in period and can be redeemed at any time subject to applicable exit loads. Debt funds are considered to be liquid as they can be withdrawn on any business day. Few Liquid funds also offer instant redemption facilities which allows investor to redeem upto ₹50,000 instantly per day per scheme per investor.

  • first-beefit
    Tax efficiency

    Debt funds can be more tax efficient than traditional investment avenues. Debt funds are taxed only when they are redeemed and the tax is only paid on the redemption proceeds unlike some of the traditional avenues which deducts TDS on the interest earned every year. The dividend received from debt funds is taxable in the hands of the investor according to the investors tax slab. Debt funds can be more tax efficient with LTCG (Long Term Capital Gain) of 20% along with the benefit of indexation when the investments are held for more than 3 years which can help provide better post-tax returns.

  • first-beefit
    Stability

    Debt funds are relatively less volatile than equity funds and can provide stability to an investor’s portfolio. This can help diversify an investor’s portfolio and bring down the overall risk. They are also considered to be a good source of relatively stable income over a period of time.

  • first-beefit
    Potential for better returns than traditional investment avenues

    Investments in debt fund have the potential to generate better returns than traditional investment avenues. An investor can also take advantage of changing interest rates and could generate income by choosing the right fund matching his risk appetite and investment horizon.

Taxability of Debt Mutual Funds*

If the units of the scheme are held for less than 3 years, then any gains are calculated as STCG(Short Term Capital Gain) and are taxed as per an individual’s tax slab whereas if they are held for more than 3 years then the gains will be calculated as LTCG(Long Term Capital Gain) and will be taxed at 20% with the benefit of indexation.

* Plus surcharge & health and education cess as per Income Tax Act. (Note – In view of individual nature of tax consequences, investors are advised to consult their financial advisor / tax consultant before making any investment decision)

Debt Funds FAQ

1. Is there any lock-in period for debt funds?

Debt funds don’t have lock-in period. An investor can choose to redeem his investments on any business day subject to applicable exit load.

2. Who should invest in debt funds?

Debt mutual fund investment are a good investment option for investors who are looking to generate regular income for short to medium term. They are suitable for investors having a low to moderate risk tolerance and are a good alternative to traditional investment avenues.

3. Are debt funds risk free?

Debt funds have certain risks involved such as credit risk and interest rate risk. Credit risk is the risk of default on a security that may arise from a borrower failing to make the required payments. This usually arises when investments are made in securities having a low credit rating. Interest rate risk is the risk of a fall in bond prices due to a rise in the interest rates.

4. Which type of debt fund is the best?

The choice of debt fund depends completely on the investor. The investor should invest in a debt fund which suits his risk appetite, investment horizon and investment objective.

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