A debt fund is a sort of investment portfolio wherein the core holding comprises of fixed income investments. Funds of such kinds could either be categorized as mutual or exchange-rate, and may invest in fixed-interest generating securities such as short-term or long-term bonds, corporate bonds, commercial paper, securitized products, and other money-market instruments. The fee ratios on debt funds are lower on average when compared to equity funds considering its lower management costs. This article is a brief account of debt funds.
Investors opt for debt funds for earning interest income and capital appreciation. The interest to be earned on these securities and the duration of the maturity of the debt security is pre-determined. For this simple reason, it is also known as ‘fixed-income’ securities.
Debt funds generally aim at optimizing returns by diversifying across various kinds of securities, thereby enabling them to earn fair returns, though without any guarantees for the same.
Credit ratings, as we all know, plays a definite role in the sanctioning of loans. Similarly, debt funds invest in securities by analyzing their credit ratings, as the same indicates the creditworthiness of the issuer. Given this, the credit manager is tasked with the role of identifying high credit quality instruments.
From the above points, we could infer that the volatility rate of debt funds which invest in higher-rated securities are lower when compared to lower-rated securities. Also, on the same page, the maturity of the debt security hinges on the investment strategy of the fund manager and the overall interest rate regime in the economy. Considering this, a falling interest rate regime encourages the manager to invest in long-term securities, whereas a rising interest rate regime prompts him/her to invest in short-term securities.
Debt mutual funds are considered apt for conservative investors opting for short-term and medium-term investment horizons. While short-term investments range between three months to one year, medium-term investments have a timeline of 3-5 years.
Types of Debt Funds
The investor may choose to enrol into any of the following debt funds:
- Dynamic Bond Funds
- Income Funds
- Short-Term and Ultra-Short-Term Debt Funds
- Liquid Funds
- Gilt Funds
- Credit Opportunities Funds
- Fixed Maturity Plans
Dynamic Bond Funds
These naturally dynamic funds require the fund manager to keep changing the portfolio composition in accordance with the changing rate of interest. Dynamic bond funds possess a fluctuating average maturity period as these funds take interest rate calls and invest in instruments of longer and shorter maturities.
Income funds often invest in securities with long maturities. However, investments are also made in debt securities with varying maturities. The average maturity period of these funds’ ranges between 5-6 years.
Short-Term and Ultra Short-Term Debt Funds
As the name indicates, such funds invest in instruments with shorter maturities ranging between 1-3 years. Short-term funds would suit the likes of conservative investors as these funds are not majorly affected by interest-rate fluctuations.
This is a risk-free version of debt-funds, the maturity period of which isn’t more than 91 days. Mutual fund companies generally offer instant redemption on liquid fund investments through special debt cards.
Gilt funds typically invest in government securities, which are high-rated and low on credit risk. These funds are appropriate for risk-averse fixed income investors.
Credit Opportunities Funds
Credit opportunities funds aim to earn higher returns by considering the credit risks and holds lower-rated bonds that come with higher interest rates. It is appropriate for avid risk takers.
Fixed Maturity Plans
Classified as closed-end debt funds, these funds also invest in fixed securities like corporate bonds and government securities. Fixed Maturity Plans will work on a fixed horizon, according to which the lock-in period is determined. FMP has the potential to deliver superior and tax-efficient returns but without any guarantee.