Debt Funds in India: Meaning & Types

You might have heard of Mutual funds, a popular way of investing your money. Two broad categories of mutual funds that are talked about are: Debt Funds and Equity Funds. Through this post, we shall be covering exclusive details on What are debt funds? Its meaning and different types of debt funds in India.

What is a Debt Fund? Meaning

Debt funds are an investment pool that invests mainly in highly rated fixed income securities like central and state government securities, corporate deposits, treasury bills, corporate bonds. These funds are managed by highly skilled professionals. The overall expense ratio is lower if we compare debt fund and equity fund, main reason for it is the overall management cost is lower.Debt funds in India, debt funds meaning, debt funds types, debt mutual funds

There is a lock-in period for several debt mutual funds and it is considered as the most effective tax saving option compared to traditional options like Fixed Deposits, Public Provident Fund etc. As far as absolute returns are concerned, debt fund gives higher return as compared to FD or PPF.

There are different types of debt funds in India. Given below are broad types of debt funds in India and different companies may call it with a different name with few changes to its characteristics.

Different Types of Debt Funds in India:

1. Gilt funds:

  • These are funds that mainly invest in government bond and securities. This not only includes centre government securities but also state government securities.
  • As gilt funds invest in paperback securities, the default risk is almost zero. However, it should be noted that zero default risk does not mean 100% safe. There exists interest rate risk.
  • It is advisable not to hold a gilt fund for the long term as the interest rate changes are quite sensitive.
  • This is an open-ended fund.
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2. Long term Debt Funds:

  • These are funds that mainly invest in┬álong term securities which might be from the Government and from the private sector alike.
  • The funds are for investors looking for better returns in longer term i.e greater than 3 years.
  • The funds are very sensitive to the policy rate and bond market fluctuations. Hence, these mutual funds should not be invested for shorter term.
  • This is also an open-ended fund.

3. Short term debt funds:

  • Commercial papers, certificate of deposits and bonds are the most common investment avenues of short term funds. Interest rate changes do not affect such investment avenues.
  • The returns offered by such short-term funds are higher as compared to gilt funds and the returns are consistent in short term funds.
  • If an investor is having an excess amount in hand and wants to invest for 12-36 months then short term fund might be a good option based on your risk profile.
  • The maturity period in short term fund is longer than the liquid funds but shorter than long term funds.
  • This is an open-ended fund.
  • There is subcategory called Ultra short term fund which is funds usually invest instruments having a maturity of 90 days to 1.5 years and are less volatile.

4. Income Funds or Hybrid funds:

  • Income funds usually invest their corpus into the entire debt instruments in the market. It could be bonds, corporate deposits, debentures and securities.
  • Income funds have a flexibility of investing its corpus to short-term instruments of 6-12 months and long term instruments of 5-10 years.
  • An investor who wants to invest for long term and is capable of taking high risk can invest in an Income fund. In the longer period, income fund tends to give higher and stable returns.
  • The perfect time to enter in Income fund is the time when interest rates have to reach to its peak and are about to reduce.
  • This is an open-ended fund.
  • Income fund is also called hybrid fund as they invest in both equity and debt in the different ratio depending upon the fund manager.
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5. Fixed maturity plans:

  • As the name suggests, Fixed maturity plans (FMPs) are having fixed tenure and invest in securities that mature after a certain period of time. On or before maturity period securities are redeemed and proceeds are paid to investors.
  • FMPs are close-ended funds.
  • In FMPs, interest rate risk is zero and the maturity amount is predictable.
  • The Net Asset Value (NAV) of FMPs will not move even if there is a change in interest rate.
  • FMPs are a feasible product for those investors who would like to invest their funds for fixed tenure and for those who don’t want to take the risk especially when interest rate trend is uncertain.
  • Ideally, FMPs are meant for a period of 3-5 years.

6. Liquid funds:

  • Liquid fund as its name says are funds that are highly liquid and mostly invest in highly liquid money market instruments like commercial papers, treasury bills, inter-bank call money market etc.
  • Among all debt funds, returns offer by the liquid fund is most stable compared to other debt funds.
  • The liquid fund can be used as an alternative of savings bank account to park excess and huge amount lying in a bank account and can give you better returns than a normal bank account.
  • It is advisable that liquid funds should be held for short period of time may be few days to a month as the returns in long run are not lucrative. This fund can be invested even for a single day.
  • Returns under liquid funds are less fluctuating as compared to other debt funds.
  • The liquid fund cannot invest in instruments that have maturity of more than 91 days.
  • Liquid funds have no exit load and can be redeemed very easily.
  • This is an open-ended fund.
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Let us put all type of the debt funds from risk and return point of view ranging from lowest to highest. The first being the liquid fund which is highly liquid and very less risky, then short-term fund and income fund; after to it is income fund and lastly gilt fund.

Debt Funds mutual funds risk return relationship pic

Investors have many options to chose from different types of debt funds in India. You may choose it as per your own risk and return factors in your portfolio.

Disclaimer: This post is not a financial advice. Please consult your financial adviser before taking an investment decision. or any of its representatives are not responsible for any loss that might happen due to your investments. Kindly follow due diligence and be cautious while investing your money in any of the risky asset classes.

We hope this post was useful in giving you requisite details on what is debt fund? You also know the various types of Debt Funds in India. So, you are in better position to plan your investments. Feel free to share your valuable feedback or any query thereon.

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