A debt fund manager usually invests in bonds issued by the government or companies who wish to raise funds for developing the nation or for expansion of business. Since these entities borrow money from people to raise funds, they promise a fixed interest in exchange. Today we are going to discuss debt mutual funds and whether investing in them is a good choice.
What is a debt fund?
When an investor invests in a debt fund, he or she is indirectly involved in the process of borrowing or lending money in exchange for fixed interest. Although debt funds invest in fixed interest generating instruments, they do not guarantee fixed returns. However, debt funds are considered to be far safer than equity mutual funds. They invest in fixed income securities like government and corporate bonds, treasury bills, commercial paper, and other debt related money market instruments.
How do debt mutual funds work?
Depending on the credit rating of the securities, debt funds managers invest in a wide range of securities. A debt security with a high credit rating means there are fewer chances of the issuers paying the interest on the predetermined date. However, debt securities with low credit ratings have the risk of default. But debt securities with low credit ratings have the potential to generate better returns than debt securities with high credit ratings. Depending on the nature of the scheme and its investment objective the fund manager may choose to build the investment portfolio of the debt fund. For example, a credit risk fund invests in securities with low credit ratings but might be able to generate better returns than other debt funds. On the other hand, gilt funds invest in government securities and government issued bonds to generate stable returns. The maturity duration of the debt security also plays an important role and hence the fund manager must ensure that he or she invests in debt securities whose maturity duration remains in sync with the investment strategy of the scheme.
What are the different types of debt funds?
Below listed are the 16 debt categories as prearranged by the Securities and Exchange Board of India (SEBI) –
- Liquid Fund
- Overnight Fund
- Money Market Fund
- Gilt Fund
- Long Duration Fund
- Floater Fund
- Ultra Short Fund
- Medium Duration Fund
- Credit Risk Fund
- Dynamic Bond Fund
- Medium to Long Duration Fund
- Corporate Bond Fund
- Banking and PSU Fund
- Gilt Fund with 10 year constant Duration
- Short Duration Fund
- Low Duration Fund
Are debt funds a good investment option?
Debt funds can be a great way for one to diversify their investment portfolio. These are mutual funds that try to protect the investor’s capital whilst generating stable returns. Equity funds are constantly dealing with market upheavals and thus adding a debt element can offer an investor’s mutual fund portfolio the much required cushion. Since these funds offer high liquid some funds like liquid funds and overnight can be utilized for building an emergency fund. Debt funds can also be considered by investors who are unhappy with their current investments in conventional instruments. These funds are best suited for investors with a short investment horizon spanning between one to three years. Investors who have received a large sum through some of their policies that recently matured can even park this money in a debt scheme and earn interest rather than letting it sit idle.
Debt funds can be a good investment option, but investors must consult their financial advisor and only after that make an informed investment decision.