What are Debt Funds and Types of Debt Funds?

2 Nov 2020  Read 861 Views

In the earlier times, and even in some rural areas today, the wealthy people used to offer their money to those who were less fortunate in the exchange of interest rate, as a means of investment. This was a good source of investment for the wealthy; however, sometimes they had to bear the loss of their money, in case some ran away or accidentally died or due to any other reason, did not return the money.

In this era, mutual funds offer higher returns and interest rates to their investors, but investors are often afraid while investing in mutual funds as they do not have any prior knowledge of the industry.

Mutual funds offer higher returns than Fixed Deposits (FD) with associated risks and different maturity periods.

In the field of finance, mutual funds are considered an effective option to attain optimal returns/interest rates on your investments. Mutual funds offer various types of options in which investors can invest their money according to their financial needs and goals. Having prior knowledge of the industry can help make the right choice of fund schemes and thus avoid any risks. Mutual funds are categorized into various types of funds.

Here we will talk about types of mutual funds based on their objective, i.e., Equity Funds and Debt Funds.

Click here to read about Equity Funds.

Debt mutual funds are divided into various subcategories according to the financial goals of the investors with various maturity periods.

Types of Debt Mutual Fund

Debt funds are an investment pool that invests money in securities that offer fixed income, which includes treasury bills, corporate funds, commercial papers, government securities, and also buying and selling of loans in exchange for interest, and other money market instruments, to generate higher returns.

This fund has a predetermined maturity date and interest that investors can get after the maturity period, which is called fixed-income securities. The return on investments does not change with fluctuations in the market, which makes it less riskier than equity fund schemes.

Debt mutual fund schemes are categorized into many subcategories, according to their characteristics.

Let’s talk about those subcategories one at a time;

Overnight Fund

The fund manager invests money in debt securities which make this fund scheme safer (as it invests in government securities which are meant to be safer investment options). It offers a higher interest rate with minimal risks as compared to other fund schemes. The maturity period is one day.

Liquidity Fund

This fund invests money in fixed income securities like government securities, commercial paper bills, treasury bills, etc. with a maturity period of 91 days. The NAV(Net Asset Value) of the fund is calculated based on 365 days.

In case investors wish to withdraw their money, this process can be done within a day which makes it a less risky and more attractive fund to invest in.

Ultra-Short Duration Fund

The fund manager invests in debt securities and money market instruments according to the financial goals of the investors. The duration period of this fund is between 3 -6 months, with good returns of 7-9% approximately.

If investors have some short-term financial goals like purchasing machinery, automobiles, etc. in 6 months, this scheme is an ideal option.

Low-Duration Fund

A Low-Duration fund invests in securities and money market instruments like other schemes of debt funds. The duration of this fund scheme is between 6-12 months.

This scheme might be ideal for those investors who wish to get higher returns within a year instead of saving their money in the bank. This scheme offers the average returns of 6.5-8.5% to its investors with a lower risk.

Money Market Fund

The fund manager invests in various money market instruments like treasury bills, repurchase agreements, commercial papers, etc. This fund scheme offers good returns within a year and maintains high levels of liquidity.

Short-Duration Fund

This fund scheme invests in money market instruments like other fund schemes of debt mutual funds. The duration of the scheme is 1-3 years.

The scheme also offers higher returns with lower risk which might be an ideal fund scheme for investors who wish to invest in mutual funds for more than a year to gain higher returns as compared to their bank’s savings account.

Medium Duration Fund

Like any other debt fund scheme, this fund scheme also invests in debt securities and money market instruments to offer higher returns. The maturity period of this fund scheme is between 3-4 years.

If an investor wishes to invest in mutual funds for 3-4 years to get higher returns, this fund scheme might be ideal for him, as it offers 7-9% of returns on the investments.

Medium to Long-Duration Fund

This fund scheme invests in money market instruments and debt securities to offer higher returns to its investors. The maturity period of this fund is 4-7%, which is ideal for the long term investors who are willing to take risks to get higher returns.

Long-Duration Fund

This fund scheme invests in debt securities with the objective to offer higher returns to its investors. The maturity period of this fund is more than 7years.

This fund offers higher returns but is more sensitive because of the interest rate fluctuations in the market.

Dynamic Bond Fund

This fund invests in various debt securities based on the interest rate. It offers optimal returns to its investors within the maturity period of 3-5 years with moderate risks.

The fund manager analyses the market cycle and according to this analysis, makes decisions to gain optimal returns.

Corporate Bond Fund

This fund invests around 80% into corporate bonds to gain optimal returns. Generally, organizations sell these bonds to raise new capital, for advertisements, insurance, premium payments, or for any other financial needs.

In exchange for the investments in mutual funds, corporates give them the interest/returns on their investments.

Credit Risk Fund

The fund manager invests in low-quality credit debt funds, which offers higher interest rates. However, higher returns generally come with higher risks.

The fund manager analyses the low credit risk funds before making the right decision to get optimal returns.

Banking and PSU (Public Sector Undertaking) Fund

Investments in banking and public companies are considered the safest investment for an investor. This fund invests in the banking sector and public companies that offer higher returns on investments with minimal risks.

The fund manager invests at least 80% of their total assets in the public companies and banking sectors as the associated risk in the investment is minimal.

Gilt Fund

This fund invests in bonds and fixed interest rate securities with various maturity periods. These bonds and fixed interest rate securities are held by the state and central government with minimal associated risk.

Floater Fund

This fund majorly invests in various debt securities offering various interest rates that depend on market fluctuations. This fund still manages to take advantage of the market cycle to attain the optimal returns for its investors. It offers a higher return with minimal risk to its investors.

Fixed Maturity Plans (FMP)

As the name suggests, ‘Fixed’ Maturity Plans is a closed-ended mutual fund, which comes up with a fixed maturity period and with a limited period of investments.

Investors can invest in this fund through NFO (New Fund Offer) launched by the AMC(Asset Management Company).

Final Thoughts

Debt funds offer various maturity periods from 1 day (overnight fund) to more than 7 years (long duration fund) with various mutual fund schemes.

Investors need to make the right decision according to their financial goals. A prior analysis of the market and the available investment schemes will make it easier for an investor to make the right choice to select the right scheme and avoid any unnecessary risk.

About the Author: Divyanshu kumar | 49 Post(s)

Divyanshu is currently pursuing a Master's degree in Financial economics. Growing up, he has always been interested in codes and numbers which he has gradually learnt to express in words too.

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