There are three different kinds of mutual funds that you can currently invest in - equity mutual funds, debt mutual funds and hybrid mutual funds. As an investor, you should know the difference and the advantages provided by these three funds. In this article, we’re going to take a look at what a debt fund is, the different types and the various benefits that they offer. Let’s begin.
A debt fund is a mutual fund that invests in a wide range of debt instruments. This includes corporate bonds, government bonds, money market instruments and other corporate debt securities.
Since debt instruments are fixed-income securities, they generally offer stable returns with relatively lower risk compared to equity. This makes a debt fund the perfect investment option for investors who are averse to risk and prefer a regular source of income.
In addition to the periodic interest payments from the debt instruments, holders of debt fund units also get to enjoy capital appreciation via an increase in the Net Asset Value (NAV).
Now that you’re aware of what a debt fund is, let’s take a look at some of the different types that you can invest in.
A liquid fund is a type of debt mutual fund that invests in instruments with a maturity period of fewer than 91 days. Investors who wish to temporarily park their funds can consider investing in them.
An overnight fund invests in money market instruments with a maturity period of just 1 day. Such kinds of funds are primarily designed to provide liquidity and convenience instead of high returns.
Ultra-short-duration funds invest in debt instruments with a maturity period of about 3 months. These funds are generally low in risk and offer slightly better returns than liquid funds.
Funds that invest in instruments that mature within 6 months to a year are known as low-duration funds. These funds are slightly riskier but provide reasonable returns.
Medium-duration funds invest in instruments with a maturity period ranging from 3 to 7 years, whereas long-duration funds have maturities of more than 7 years. These funds are ideal for those who are willing to invest for the long term.
Such funds invest in money market instruments such as treasury bills, commercial papers (CPs), certificates of deposits (CDs) and commercial bills. Money market funds usually have a maturity period of less than 1 year.
Fixed Maturity Plans, also known as FMPs, are close-ended mutual funds. These funds have a fixed tenure and invest in debt securities with tenures that match that of the fund. Since the debt securities are held till maturity, FMPs provide investors with a steady flow of passive income.
Such types of debt mutual funds invest at least 80% of the total fund value in corporate bonds rated AA+ or higher. Corporate Bond Funds generally offer higher rates of return compared to other debt mutual funds.
Gilt funds are debt funds that invest exclusively in government securities (G-Secs). These funds can either be short-term or long-term depending on the kind of government securities that they invest in. Since government securities are the safest investment options in India, Gilt funds carry zero default risk, making them the perfect option for risk-averse investors.
By investing in debt mutual funds, you get to enjoy a plethora of benefits. Here’s a closer look at what they are.
If the Net Asset Value (NAV) of debt funds rises, you can cash in on the value appreciation by selling off your units.
In addition to capital appreciation, many debt funds also provide regular interest payments which are disbursed to you. These regular interest payments are a great source of passive income.
Compared to equity mutual funds, the risks associated with debt funds are significantly lower. This makes them the perfect option for investors with low to moderate risk tolerance.
As you’ve seen in the previous section, there are multiple kinds of debt funds that you can invest in. You have the freedom to choose the fund that fits your goals and requirements.
Debt mutual funds are very liquid. This allows you to easily buy and redeem units of the fund without any hassles whatsoever.
Unlike other mutual funds, the expense ratio of debt mutual funds tends to be very low. In fact, according to SEBI, it cannot be more than 2% of the AUM.
Debt funds are actively managed by an experienced fund manager or a team of managers. They constantly monitor the performance of the funds to ensure that it is in line with the laid out objectives.
With this, you must now be aware of the benefits of debt mutual funds. Contrary to popular opinion, these funds are not just meant for investors with low-risk tolerance. Even if you’re a risk-aggressive investor, you can consider investing in a debt fund. Doing so can not only help you diversify your portfolio but also protect you from market downsides.
However, before you proceed to invest in a debt mutual fund, you need to first open a demat account. Motilal Oswal offers a robust 2-in-1 trading and demat account for free. Head on over to the website and apply for one today.