What are Debt Funds and their types

June 1, 2020
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Debt funds are mutual fund instruments that invest in fixed income securities, some of which are government bonds, commercial paper, treasury bills, etc. Normally, debt funds are low-risk investments. In comparison to equity funds, debt funds provide more stability to a portfolio. Investors with a low-risk appetite prefer debt funds as they offer consistent returns.

People opt these funds because they provide regular income at low risk. However, there is a twist in the story as debt funds don’t offer high returns like equity funds. But debt funds still amass capital appreciation when investments are made for a longer term.

Debt funds can also help an equity investor maintain a balanced portfolio. A balanced portfolio can manage the high risk of an equity instrument with the stability of a debt fund.

Types of Debt Funds

Debt funds are mostly classified depending upon their credit risk or maturity. Some maturity-based investments are short term debt fund and long term gilt fund. Meanwhile, credit risk-based debt funds can be categorised as credit opportunities funds, G-Sec funds, etc.

Here are some of the most known types of debt funds-

Short, Medium, and Long Term Debt Funds

Short term debt funds have a maturity period of 1 to 3 years. Meanwhile, medium term funds have a maturity period of 3 to 5 years, and long term funds have a maturity duration of more than 5 years.

Interest rate risk doesn’t have a huge impact on short term funds as the maturity period is low. Hence, investors with a low-risk appetite should consider these funds. However, the risk is comparatively higher with medium and long term debt funds. It is because the interest rate impact rises as the maturity period increases.

Liquid Funds

Liquid funds are debt funds that have high liquidity. The maturity period of this instrument is between 1 day and 91 days. Liquid fund investments are made in money market instruments. There are Some liquid funds that offer instant redemption of up to Rs. 50,000. Liquid mutual funds are one of the least risky investment instruments.

Fixed Maturity Plans

Fixed Maturity Plans (FMPs) are closed-ended mutual funds that have a lock-in period. The lock-in period is based on the scheme. Investment in Fixed Maturity Plans can be made only during the initial offer period.

Fixed Deposits (FDs) and Fixed Maturity Plans are almost identical. However, there are two differences between FMPs and FDs. Fixed Maturity Plans provide no assurance of fixed returns, but they do offer more tax benefits than FDs. FMPs are considered one of the best debt funds if an investor wants to increase tax-efficiency.

Dynamic Bond Funds

Dynamic bond funds aredebt funds for which an investor requires a fund manager’s supervision. The fund managers invest in schemes based on interest rates’ predictions, and these predictions help them modify a portfolio’s maturity period. Dynamic bond funds can have a shorter maturity period of 1 to 3 years or longer maturity duration of 3-5 years.

Gilt Funds

Gilt fund investments are made in government securities. State and Central governments offer these funds, and there is no risk of non-payment with gilt funds. However, these funds are impacted by interest rates’ movements.