Debt Funds

A type of pooled fund in which the assets held are in the form of fixed income financial instruments. Types of fixed income instruments that a debt fund may invest in include short-term bonds, long-term bonds, money market funds and other securitized debt.

The main investing objectives of a debt fund will usually be preservation of capital and generation of income. Performance against a benchmark is considered to be a secondary consideration to absolute return when investing in a debt fund.

What is Debt Funds??

An investment pool, such as a mutual fund or exchange-traded fund, in which core holdings are fixed income investments. A debt fund may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. The fee ratios on debt funds are lower, on average, than equity funds because the overall management costs are lower.


1. Liquid funds

Liquid funds are an uncertain investor's biggest ally. Whether the investor is uncertain with regards to the interest rate scenario or uncertain about what he wants to do with his money is immaterial; liquid funds are an answer to both these uncertainties. Liquid funds are ideal for investors who have a very short investment time frame, as short as a day. So you can invest your money in a liquid fund till such a time that the uncertainty (with regards to interest rates in this case) is dispelled.

Since liquid funds usually have very similar portfolios (consisting of money market instruments and call money), there is not much product differentiation over there. However, given that liquid fund returns are wafer-thin, it is imperative to select the ones with the lowest expense ratios. 

2. Gilt Funds

They invest their corpus in securities issued by the government. These funds carry zero default risk but are associated with interest rate risk. So, there could be a possibility that the debt funds lose some part of their net asset vale (NAV) also. But these schemes are safer as they invest in papers backed by government.

3. Monthly Income Plan (MIP)

They invest most of their corpus in debt instruments and minimum in equities. They get the benefits of both equity and debt market. These schemes ranks slightly high on the risk-return matrix. These try to give you a monthly income in the form of dividends, which is of course not guaranteed. These funds are for investors, who have a big corpus initially, and would like to generate a monthly income for themselves with low to moderate risk.

4. Short-term debt funds 

Another fund that fits the bill for an uncertain investor's portfolio is the short-term debt fund. While liquid funds do the job of insulating the investor's portfolio from high interest rates well enough, short-term debt funds do it as well and can even give a slightly higher return. The difference between a liquid fund and a short-term debt fund is the investment tenure. Liquid funds are ideal for investors with an investment tenure ranging from 1 day to 30 days. While investors can remain invested in liquid funds for longer than that, the return may begin to look a little unattractive compared to the next product on the maturity parameter i.e. short-term debt funds

3. Floating rate funds 

This is the only long-term debt fund we would recommend investors to consider in a rising interest rate scenario. This is mainly due to the fact that floating rate funds are better geared to take on rising interest rates. Floating rate funds invest in debt instruments that have their coupon rates linked to a reference/benchmark like the MIBOR (Mumbai Interbank Offered Rate) for instance. The MIBOR is a good barometer of the prevailing interest rate scenario in the country. The coupon rate on the debt paper is revised regularly in line with changes in the MIBOR. So at the end of the day, the floating rate debt instrument (and the floating rate debt fund) captures the interest rate mood fairly well, at least a lot more effectively than the fixed rate debt instrument. 

Other Types

• Diversified debt funds
• Junk bond schemes
• Fixed maturity plans

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