Debt mutual funds: Introduction, Types, and Operation
If you are seriously considering opting for an investment in mutual funds, it is important to remember that you should sign up for the right type of mutual fund scheme. Mutual funds are not a monolith, and several variants of mutual fund schemes are available in India for investment options. Each of these different variants of mutual funds are known to cater to different types of investment needs. Also, just like different types of mutual funds are known for being suitable for different investment needs, they also come with different level of risk levels. After determining their risk appetites, an investor opts to sign up for one of these different variants. One of the different types of mutual funds is debt funds or debt mutual funds.
What are debt funds?
Debt funds are mutual fund schemes that are known for investing in debt instruments like corporate debt securities, corporate and government bonds, and money market instruments. Also, there are different types of debt funds that are known for suiting investors with varying investment horizons, financial goals, and risk-return profiles. Debt mutual funds allocate funds to government securities, certificates of deposits, commercial paper, securitized debt, treasury bills, money market instruments, and corporate bonds. As they are known for investing in fixed-income securities, these schemes are also known as fixed-income funds or bond funds.
One of the major differences between a debt and an equity mutual fund is that they are known for directing investments towards different asset classes. Equity funds allocate approximately 65% or more of their assets into both equity and equity-related instruments. Conversely, debt funds invest mainly in bonds and cash assets.
The value of an investment is dependent on the prices of the securities that are a part of the investment. As prices of bonds usually tend to be less volatile than that of stocks, the value of debt funds is more stable than the value of equity funds. In simple words, debt funds are less risky, especially when held for short periods of time.
What are the different types of debt funds?
Listed below are some of the different variants of debt mutual funds:
– Dynamic bond funds:
In accordance with the name ‘dynamic bond funds,’ the fund manager keeps on changing portfolio composition according to the fluctuating interest rate regime. As they invest in instruments of longer and as well as shorter maturities and take interest rate calls, dynamic bond funds are known for having different average maturity periods.
– Short-term and ultra-short-term debt funds:
This type of debt fund is known for investing in instruments that come with shorter maturities, i.e., the ones ranging from one year to three years. Short-term funds are suited for conservative investors because these funds are not affected that much by interest rate movements.
– Liquid funds:
Liquid funds direct investments towards debt instruments that have a maturity of not more than 91 days. This aspect makes these funds almost risk-free. They have rarely ever seen negative returns. Also, liquid funds are known for being a better alternative to savings bank accounts. That’s because they provide similar liquidity with higher yields. Numerous AMCs are known for offering instant redemption on liquid fund investments through debit cards.
– Income Funds:
Under income funds, a fund manager firstly takes a call on the interest rates and then invests predominantly in debt securities that have extended maturities. This makes these funds more stable than dynamic bond funds. Generally, income funds come with an average maturity of approximately five to six years.
How do debt funds operate?
A financial expert managing your portfolio referred to as a fund manager is known for allocating funds to securities such as debt or money market instruments. This action is taken by the fund manager with a single aim. The aim is to enjoy revenue in form of interest payments. In contrast to equity mutual funds, debt funds are known for having significantly lesser risks. Comparatively lower investment risk is the reason why investors are attracted to these funds.