A Primer on the Different types of Debt Mutual
Funds
Are you scared of investing in mutual funds because
it invests in the equity markets? Most of us assume that investing in mutual
funds is akin to investing in the stock market. However, that is not the case.
There are mutual funds that do not invest in equities. Debt mutual fund, a
category of mutual fund invests in the debt securities issued by the government
and various companies.
Debt is an asset class which is less volatile than
equities. Government bonds, state development loans, treasury bills, corporate
bonds are some of the types of debt instruments. These debt instruments
come with different maturities and risk.
Debt mutual funds invest in these securities
according to the scheme’s investment objectives. Based on the underlying
securities, debt funds can be segregated into a few categories. Depending on
the time horizon, investors can choose the debt funds based on the maturity
periods of the papers held by these funds. Different debt funds are meantfor
different investors.
Here are some of the main types of debt funds:
Liquid Fund: Liquid
Fund carries the lowest risk among the different mutual fund categories. It has
the lowest risk as it invests in high-quality debt papers that mature within 91
days.
The main objective of liquid funds is to provide
liquidity. It helps investors to park surplus cash for certain period and
receive better returns than savings account. Unlike fixed deposits, liquid
funds do not have any maturity period. You can also redeem money from liquid
funds instantly. Currently, investors can redeem up to Rs.50,000 or 90% of the
total amount, whichever is lower, instantly.
Also, in view of the series of downgrades and defaults,
the market regulator has laid down stricter norms for liquid funds. According
to the new guidelines, liquid funds have to invest at least 20% of their
portfolio in liquid assets such as cash, government securities, treasury bills
and repo instruments. Moreover, liquid funds can now invest only up to 20% in a
single sector and not more than 10 per cent in housing finance companies.
Liquid Funds are good investment option for your
short term goals such as planning for a vacation or saving money for a new
laptop.
Overnight Funds:As the name
suggests, these debt funds will invest in overnight securities that mature in
one day. It can be a good investment option for individuals who want to park
their money for a day or two.
Money Market Funds:
Money Market funds will invest in money market instruments with a maturity
period of within 1 year. Money market instruments include
Duration Funds: These
debt funds invest in debt securities with a maturity period. Ultra-short
duration funds, low duration fund, short-duration fund, medium duration funds,
medium to long-duration funds and long duration funds are the different
categories of duration funds. Ultra-short duration fund will invest in debt
securities with a maturity between three months to six months. Low
duration fund, short duration fund, medium duration funds, medium to long
duration funds and long duration funds will invest in papers maturing six to12
months, one year to three years, three years to four years, four to seven years
and greater than seven years respectively.
Duration funds will help you to invest in a fund
based on your time horizon. E.g., if you are planning for a vacation in the
next six to 12 months, you can invest in a low duration fund.
Dynamic Bond Funds
While the duration funds invest in papers with a
fixed maturity period, dynamic bond funds can invest in papers maturing at
different time periods. The average maturity of the papers of these funds will
depend on the interest rate scenarios. If the fund manager believes that the
interest rate is likely to inch lower, they will increase the allocation of the
long term bonds such as government bonds and vice versa.
Corporate Bond Funds
Corporate bondfunds primarily invest in high rated
corporate bonds. Corporate bonds are issued by various companies. According to
the recent SEBI guidelines, corporate bond funds have to invest nearly 80% of
their portfolio in AAA-rated corporate bond funds. Corporate bond funds carry
higher risk than ultra-short and short term funds and hence it is suitable for
investors who can take higher risk.
Credit Risk Funds
Credit Risk Funds mainly invests in debt securities
that are rated AA by various agencies. Fund managers invest in lower-rated
papers that are likely to be upgraded in the future, which increases the value
of the paper. As it invests in lower than AAA-rated papers, credit risk funds
also have the potential to give higher returns than other debt funds. However,
it also comes with higher risk as well.
Gilt
funds
Gilt funds only invest in government securities of
different maturities. Gilt funds perform well when the interest rate is moving
south.Investors who want to invest for the long run can invest in these funds.
It also comes with higher risk than short term debt funds.
Conclusion:
If you are looking for a tax-efficient investment
option that carries lower risk, debt funds can be a good investment option.
However, as discussed above, different categories of debt funds carry different
risks. So, research is highly recommended before investing in debt funds. In
case of further queries, you can always reach out to your financial advisor.
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