Debt mutual funds are a type of mutual fund that primarily invests in fixed-income securities such as government bonds, corporate bonds, debentures, money market instruments, and other debt securities.
These funds are managed by professional fund managers, who make investment decisions based on the fund's objective and the prevailing market conditions.
Here are some key features of debt mutual funds:
Fixed-Income Securities: Debt mutual funds predominantly invest in instruments that provide a fixed rate of return. These securities pay periodic interest, and the principal amount is repaid at maturity.
Diversification: Fund managers diversify the portfolio by investing in a mix of debt instruments with varying maturities, credit qualities, and issuers. This diversification helps manage risk and enhance returns.
Risk and Return Profile: Debt mutual funds are generally considered lower risk compared to equity funds. However, they are not entirely risk-free. The level of risk depends on the types of securities held in the portfolio. Higher-yielding securities often come with higher risk.
Liquidity: Debt mutual funds offer relatively higher liquidity compared to individual bonds. Investors can buy or sell units of these funds at the prevailing Net Asset Value (NAV) on any business day.
Tax Efficiency: Debt mutual funds are taxed like other fixed-income products. The capital gains earned from such schemes are taxed as per the slab rate applicable to the individual and no long-term capital gains or indexation benefits are available.
Interest Rate Sensitivity: Debt funds are sensitive to changes in interest rates. When interest rates rise, the prices of existing bonds in the portfolio may fall, impacting the fund's NAV. Conversely, falling interest rates can lead to capital appreciation.
Types of debt mutual funds: There are several types of debt mutual funds available based on the maturity period, quality of securities, and investment objectives. Some of the popular types include:
Short-Term Funds: These funds have a maturity period ranging from 1 to 3 years and invest in government securities, debt, and money market instruments.
Liquid Funds: These funds invest in debt and money market instruments like commercial papers, certificates of deposit, and treasury bills that mature within 91 days. They have very low interest rate risk due to their short maturities.
Income Funds: These funds invest in fixed-income instruments and aim to provide regular income to investors.
Dynamic Bond Funds: These funds invest in debt securities across various maturities and are suitable for investors with a moderate risk appetite
Gilt Funds: These funds invest in government bonds of varying maturities and are considered safe investment options.
Fixed Maturity Plans (FMPs): These funds invest in debt securities with a fixed maturity period and are suitable for investors with a low-risk appetite.
Credit Risk Funds: These funds invest in debt securities with higher credit risk, offering higher returns in exchange for taking on additional risk.
Overnight Funds: These funds invest in fixed-income instruments that mature overnight, such as commercial papers and certificates of deposit. They have no credit risk but offer low yields.
How does a debt fund earn a return? A debt scheme earns a return for investors in two ways. One, they get interest income, which generates accrual income. Second, as and when interest rates fall/rise, bond prices move up/down, resulting in capital gains/losses. Both the gains combined are the final return to the investor.
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