Guide to Mutual Funds
Debt Mutual Funds
A debt mutual fund invests in fixed income securities such as government and corporate bonds, treasury bills, commercial papers, and others.
These instruments have a predetermined maturity date and an assured interest rate. Hence, these are called fixed-income instruments. Since these instruments assure a fixed income, they have a low-risk profile.
How do they work?
The main objective of debt funds is to generate returns by investing money in fixed income securities. The returns generated by debt funds are linked to the yields of these fixed-income funds.
Since debt instruments are subject to default risk, most fund managers try to focus on bonds and papers with high credit value or those issued by the government.
Please note: Although debt mutual funds invest in fixed-income instruments, there is no guaranteed return. The returns remain in the expected range.
The NAV of debt funds rises and falls as per the interest rates of debt instruments in the economy. In fact, the two are inversely proportional as in when interest rates rise, the NAV of debt instruments fall and vice versa.
Who is it Ideal For?
Debt mutual funds are ideal for investors who are risk-averse and cannot afford to lose money.
Risks in Debt Funds
Debt funds are famous for their low-risk profile. But does that mean there is no risk at all?
Absolutely not! Fund houses are exposed to three kinds of risks related to debt funds:
1. Credit risk or default risk – if the issuer of the bond does not pay the interest or pay back the principal amount.
2. Liquidity risk – risks of not having enough liquidity when faced with redemption pressures.
3. Interest rate risk – arising out of changing interest rates in an economy.
As an investor investing in schemes offered by fund houses, you are exposed to the above risks as well.
Types of Debt Funds
Debt funds can be of various types:
◉ Liquid Funds – These funds invest in money market instruments with a maximum maturity of 91 days. They offer better returns than a savings bank account and are ideal for investing those funds that you do not need in the short term (3-months or less).
◉ Money Market Funds – These funds invest in money market instruments with a maximum maturity of 1-year. These funds invest in low-risk debt securities.
◉ Dynamic Bond Funds – A dynamic bond fund invests in debt instruments with varying maturity depending on the interest rate forecast of the economy. The instruments can have a maturity ranging from 1 to 5-years. They have a slightly higher risk profile than liquid funds or money market funds.
◉ Gilt Funds – These funds invest a maximum of 80% of their total assets in bonds issued by the government of India. These funds do not carry any default or credit risk.
◉ Corporate Bond Funds – These funds invest up to 80% of their total assets in corporate bonds with the highest ratings. Investors who are looking to invest in corporate bonds can opt for these funds to diversify their portfolios.