The Different Types of Debt Funds
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When we hear the word ‘investing’ or ‘mutual funds’, risk is the first thing that comes to the mind of most people. But the risk is not a uniform measure as the level of risk will vary from one investment option to another.
Risk is an inherent element of equities. However, there are mutual fund investments that do not invest in equities. Debt fund is a category of mutual funds that invests in debt securities issued by the government and various companies. Pure debt funds do not have exposure in equities.
As debt funds don’t invest in equities, the risk associated with these funds is also lower than equity funds. The objectives of debt funds include protecting capital, generating income along with moderate inflation-beating returns.
Debt fund managers play on two main investment strategies: duration and accrual. In the duration strategy, fund managers invest in papers with a favourable time horizon, while, in the accrual strategy, the fund manager invests in papers with lower investment ratings on the expectation that the rating will increase in the due course.
In the previous article, we have seen the different types of mutual funds. If you haven’t read it, click here to read. There are different types of debt funds as well. The risk and the time horizon of the different debt funds will vary across the spectrum.
Here are the different types of debt funds:
As the name suggests, the main objective of a liquid fund is to maintain liquidity. Liquid funds are used to park excess cash for a specific period of time. It invests in high-quality papers that mature within 91 days. The liquid fund is best for investors who want to park surplus cash or save to fulfil a short term goal. It carries the lowest risk among all the debt funds. It also gives higher returns than a savings account. However, you need to remember, fund houses don’t give a fixed rate of interest and your initial investment may also come down.
Read : Savings vs Liquid Fund: Which one is the best for you?
Ultra short term and short term debt funds are ideal investment options with a time horizon of 1 year to 3 years. This gives higher returns than liquid funds with minimal risk.
The underlying securities of these funds mature within 1 year to 3 years. With the increase in the maturity period, the risk associated with these funds is slightly higher than liquid funds.
Credit opportunities fund is a category of debt fund that plays on the accrual strategy. These funds invest in debt securities that are rated AA by rating agencies. Fund managers do the due research and select papers that are likely to be upgraded to AAA. This helps the fund to benefit from both high returns and increase in value. This category of the debt fund carries higher risk as well. It is suitable for investors with higher risk appetite.
The main objective of income funds is to give a stable rate of return that would help investors create an income source. Fixed maturity plans (FMPs) is a close-ended mutual fund that comes with a fixed maturity period. Currently, income funds primarily invest in corporate bonds that mature around three years.
Dynamic bond funds invest in bonds of varying maturity. The objective of the fund is to give optimal results in both the interest rate scenarios. Fund managers can strategically invest in long term bonds or short term bonds based on the interest rate outlook. For e.g., when the interest rate is likely to fall or is falling, the fund manager will increase the allocation of long term bonds such as government bonds.
Gilt funds invest in government securities of various maturities. It is an ideal investment option for long term debt mutual fund investors with higher risk-taking capacity. It performs well when the interest rate is moving south. However, when the interest rate starts to harden, the schemes lose the most . Hence, timing in gilt funds is important.
As debt mutual funds don’t invest in equities, it is a good investment option for risk-averse investors. There are different debt funds that come with different risk and for different investment horizon. So, it is important to research the various debt funds before selecting your mutual fund.
Tags: debt mutual fund, mutual fund, debt fund
