What are Debt Funds, exactly?

Debt funds are mutual fund schemes that invest in fixed-income securities such as Commercial Papers (CP), Certificates of Deposit (CD), Corporate Bonds, T-Bills, government bonds, and other money market instruments. These securities have a fixed maturity date and interest rate that purchasers can earn until the security matures. They are less volatile than equities funds, making them excellent for risk-averse investors seeking stability in their assets.

Debt Funds: What Are They and How Do They Work?

Depending on the maturity length, risk profile, and investment aim of the investor, numerous types of debt mutual funds are available.

Overnight Savings Account

This fund invests in short-term assets with a one-day maturity. Because of their short maturity duration, Overnight Funds have little credit and interest rate risk, and are thus believed to be reasonably stable.

Liquid Asset Management

Liquid Fund invests in debt and money market assets having a maximum remaining maturity of 91 days. The underlying products are fairly liquid, and they have the potential to provide better returns than typical investment options. Some liquid funds additionally provide an instant redemption option, allowing for redemptions of up to $50,000 per day per scheme and per investor.

Ultra-Short Duration Fund

Ultra-Short Duration Fund is a mutual fund that invests in ultra-short
Extremely little duration The portfolio’s Macaulay Duration is between 3-6 months since the fund invests in debt securities and money market instruments.

Low-Durability Fund

Low Duration Funds specializes in debt instruments and financial instruments so that the portfolio’s Macaulay Length is between 6 and 12 months.

Money Market Investment Trust

Money Market Fund invests in short-term money market assets having a one-year maturity. This fund is a smart place to put excess cash for the near term. It may also be used as an emergency fund because it is very liquid and has the potential to outperform traditional investments.

Short-Term Investment Fund

The portfolio of the Short Duration Fund is made up of debt securities and money market instruments with a Macaulay Duration of 1-3 years.

Medium-Term Investment Fund

The Macaulay Duration of the portfolio is between 3 and 4 years, hence the Medium Duration Fund deals in debt securities and money market funds.

Bond Fund for Companies

Corporate Bond Fund mostly invests in corporate bonds with an AA+ or higher credit rating. It’s an excellent choice for investors with a moderate risk appetite who wish to put their money into papers with a reduced credit risk.

Credit Risk Insurance Fund

This fund primarily invests in paper with an AA or lower credit rating (excluding AA+ rated corporate bonds). The Credit Risk Fund seeks to increase profits by investing in papers with higher interest rates. They do, however, pose a credit risk as compared to other debt funds.

Banking and Public Sector Undertakings (PSUs)

The Banking & PSU Fund invests at least 80% of its assets in debt and money market securities issued by banks, public sector undertakings, public financial institutions, and local governments.

Bond Fund with a Twist

Investing in debt securities with variable maturities based on current interest rates is what Dynamic Bond Funds do. The portfolio is dynamically changed by the fund management based on interest rates. These funds are a suitable choice for investors with a moderate risk tolerance who want to produce consistent income over the medium term.

Investing in Gilt Funds

Gilt funds invest at least 80% of their assets in government bonds of various maturities. They are regarded as one of the most secure investments because to their exposure to sovereign papers, which carries extremely minimal credit risk. For risk-averse investors, gilt funds are an excellent alternative.

Debt Fund Benefits – Why Invest in Debt Funds?

1. Liquidity

Debt funds, unlike conventional funds, do not have a lock-in period and can be redeemed at any time, subject to exit loads. Debt funds are liquid because they may be withdrawn at any time throughout the business day. Few Liquid funds also provide immediate redemption options, allowing investors to withdraw up to $50,000 each day, per scheme, per participant.

2. Efficient taxation

Debt funds might save you money on taxes compared to other investing options. Unlike other traditional channels that deduct TDS on the interest generated every year, debt funds are only taxed when they are redeemed, and the tax is only paid on the redemption proceeds. In the hands of the investor, the dividend paid from debt funds is taxed according to the investor’s tax bracket. Debt funds can be more tax efficient since they have a 20% LTCG (Long Term Capital Gain) rate and the advantage of indexation when held for more than three years, which can assist deliver superior post-tax returns.

3. Stability

Debt funds are less volatile than equity funds and can help to keep an investor’s portfolio stable. This can help investors diversify their portfolios and reduce overall risk. They’re also seen to be an excellent long-term source of reasonably consistent income.

4. There’s a chance you’ll make more money than you would if you invested in traditional ways.

Debt fund investments have the potential to outperform other investment options. By selecting the correct fund to meet his risk appetite and investment horizon, an investor may take advantage of fluctuating interest rates and potentially create income.

Debt Mutual Funds’ Taxability*

If the program’s units are kept for less than three years, any profits are treated as STCG (Short Term Capital Gain) and taxed at the individual’s tax rate, however if they are held for more than three years, the gains are assessed as LTCG (Long Term Capital Gain) and taxed at 20% with indexation.

  • In addition to the surcharge and health and education cess imposed under the Income Tax Act. (Note: Due to the unique nature of tax ramifications, investors should consult their financial adviser / tax expert prior to making any investment choice.)

Frequently Asked Questions about Debt Funds

Is there any lock-in period for debt funds?

No lock-in period exists for debt funds. An investor can redeem his investments at any time throughout the business day, subject to any exit load that may apply.

Who should invest in debt funds?

Debt mutual funds are a suitable investment option for those searching for a consistent stream of income over the short to medium term. They are a viable alternative to standard investing channels for investors with a low to moderate risk tolerance.

Are debt funds risk free?

Credit risk and interest rate risk are two risks that debt funds face. Credit risk refers to the possibility of a security defaulting as a result of a borrower’s failure to make due payments. This is most common when investing in assets with a poor credit rating. The danger of bond prices falling owing to an increase in interest rates is known as interest rate risk.

Which type of debt fund is the best?

The investor has total control over the debt fund he or she chooses. The investor should choose a debt fund that matches his risk appetite, time horizon, and investment goal.