what are the different types of debt mutual funds

The debt market, also known as the bond or credit market, is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. These securities are typically in the form of bonds, but may also include notes, bills, and so on. Many investors with a lower risk tolerance prefer debt securities since they are considered less risky than equity investments. Compared to equity investments, debt investment returns are relatively lower. Additionally, there are different types of debt funds based on the type of securities they invest in and their maturity (time horizon). Here, you can explore different types of debt mutual funds.

What are Debt Funds?

A debt fund invests in securities that generate fixed income, such as Treasury bills, corporate bonds, commercial papers, government securities, and many other money market instruments. All of these instruments have a predetermined maturity date and interest rate that the buyer can earn on maturity. The returns are usually not affected by market fluctuations. As a result, debt securities are regarded as low-risk investments.

How Do Debt Funds Work?

Each debt security is assigned a credit rating, which provides investors with insight into the possibility of the issuer defaulting. Using these ratings, debt fund managers select high-quality debt instruments. Higher ratings indicate a lower risk of default for the issuer.

A Debt Fund can also invest in a low-quality debt instrument. The selection of securities by fund managers is influenced by a number of factors. A fund manager might take a calculated risk by choosing low-quality debt securities for the purpose of earning higher returns on debt investments. Nevertheless, a debt fund with high-quality securities in its portfolio will be more stable. Depending on the interest rate regime, the fund manager can also invest in long-term or short-term debt securities.

Who Should Invest in Debt Mutual Funds?

Investors with a moderately lower to moderate risk tolerance can consider debt funds. The goal of debt funds is to provide stable returns by diversifying across various securities. In addition, debt funds are suitable for investors with a short-term investment horizon of 3-12 months and a medium-term investment horizon of 3-5 years.

Different Types of Debt Mutual Fund

Below is the list of debt funds types based on maturity period:

1. Liquid Fund: A liquid fund is a type of debt mutual fund that invests in money market and debt instruments with a maturity of up to 91 days, prioritizing high liquidity and capital safety over high returns.
2. Money Market Fund: Money market funds are a category of debt mutual funds that invest in a diversified portfolio of money market instruments with a maximum maturity of one year, such as Treasury Bills, Commercial Papers, and Certificates of Deposit.
3. Dynamic Bond Fund: The fund invests in a variety of debt securities with varying maturities, such as government and corporate bonds.
4. Corporate Bond Fund: This type of fund invests a minimum of 80% of its total assets in high ratings corporate bonds.
5. Banking and PSU Fund: This fund invest at least 80% of its total asset in debt securities of PSUs (Public Sector Undertakings) and banks.
6. Glit Fund: This fund invests at least 80% of its investible corpus in government securities across varying maturities.
7. Credit Risk Fund: Credit Risk funds are a special category of debt funds which invest at least 65% of the portfolio in below highest-rated corporate bonds.
8. Floater Fund: The fund invests a minimum of 65% of its investible corpus in floating rate instruments. Interest rate risk is low for these funds.
9. Overnight Fund: This fund invests in debt securities having a maturity of 1 day. These are considered safe as both credit and interest risk are negligible.
10. Ultra-Short Duration Fund: The fund invests in money market instruments and debt securities with a Macaulay duration of 3-6 months.
11. Low Duration Fund: The fund invests in money market instruments and debt securities in a manner that the maturity duration of the scheme is between 6-12 months.
12. Short Duration Fund: It invests in money market instruments and debt securities whose maturity duration is between 1-3 years.
13. Medium Duration Fund: Funds of this type invest like short duration funds, but their investments have 3-4 year Macaulay durations.
14. Medium to Long Duration Fund: This fund invests in money market instruments and debt securities with a maturity duration between 4-7 years.
15. Long Duration Fund: They invest primarily in debt securities and money market instruments with maturities over 7 years.

Factors to Consider Before Investing in Debt Mutual Funds in India

Before investing in different types of debt mutual funds in India, you should consider the following factors:

• Risks in Debt Funds

Debt funds have three types of risks:

1. Credit Risk: It is the risk that the issuer will not repay the principal and interest.
2. Interest Rate Risk: Risk associated with changing interest rates that affect the value of securities in the scheme.
3. Liquidity Risk: A liquidity risk is a situation in which the fund house does not have enough liquidity to meet redemption requests.

• Returns

Debt funds offer relatively lower returns than equity funds. In addition, there is no guarantee of returns. Depending on the interest rate, debt fund NAVs fluctuate. An increase in interest rates will result in a decline in a debt fund's NAV and vice versa.

• Expense Ratio

An expense ratio represents a percentage of a fund's assets that pays for fund management services. Expense ratios are important since debt funds may not generate high returns. Make sure you choose schemes with a low expense ratio and stay invested for a long time.

Conclusion

In comparison with equity, the returns are relatively low. Various debt funds types are available to suit the needs of different investors. Moreover, consider various risks before investing in debt funds types, including credit risk, interest rate risk, liquidity risk, etc.

FAQs on Types of Debt Mutual Funds

Is a debt mutual fund good?

Debt mutual funds can be a suitable option for investors seeking stability, regular income, and moderately high- moderatem risk.

What are the drawbacks of debt funds?

Due to credit and interest rate risks, debt funds are subject to some risk.

What are the benefits of debt funds?

The benefits of debt funds include diversification across debt instruments, which mitigates risk, and liquidity, which allows investors to buy and sell units easily.

Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.

Axis Bank Ltd. is not liable or responsible for any loss or shortfall resulting from the operation of the scheme.

Past performance may or may not be sustained in future.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.