People often invest their hard-earned money in the debt market to make profits. This market involves various instruments that allow the buying and selling of loans in exchange for interest. Debt investments are generally considered less risky than investing in stocks, making them a choice for investors with a lower risk tolerance. However, it’s important to note that debt investments typically offer lower returns compared to investing in stocks. In this discussion, we will delve into Debt Funds, exploring the different types, benefits, and more.
Debt Fund Meaning:
A Debt Fund is an investment option that puts money into securities generating fixed income. These securities include treasury bills, corporate bonds, commercial papers, government securities, and various other money market instruments. These instruments have a predetermined maturity date and interest rate, ensuring a fixed income for the investor when they mature. This characteristic gives them the name “fixed-income securities.” Unlike other investments, the returns on debt funds are generally not affected by market fluctuations, making them a low-risk choice. Now that you know debt fund meaning, let’s understand its working and different types.
How Debt Funds Work:
Each debt security comes with a credit rating, indicating the likelihood of the issuer defaulting on paying back the principal and interest. Debt fund managers use these ratings to choose high-quality debt instruments. A higher rating suggests a lower chance of default by the issuer.
Different types of Debt funds
There are various types of debt funds designed to meet the needs of different investors, considering their risk tolerance, investment timeframes, and financial objectives:
Overnight Funds: Invest in securities with a maturity of 1 day, mainly money market instruments. These are suitable for short-term parking of funds.
Liquid Funds: Invest in debt securities with a maturity of less than 91 days, offering stable returns and minimal NAV volatility.
Ultra-short Duration Funds: Ideal for investors with a horizon of at least 3 months, providing slightly higher yields than liquid funds with low risk.
Low-Duration Funds: Moderately risky, offering reasonable returns for investors with a 6-month to one-year investment horizon.
Money Market Funds: Invest in debt instruments with a maturity of up to one year, aiming for returns from interest income with a slightly longer duration.
Short-Duration Funds: Combine short and long-term debt investments, suitable for 1-3 years investment horizon, with higher returns and NAV fluctuations.
Medium, Medium to Long, and Long Duration Funds: Varying durations for different investment horizons, investing in short and long-term debt securities, with higher interest rate risk.
Fixed Maturity Plans (FMPs): Closed-end funds investing in debt securities with maturities matching the scheme term, providing interest rate risk elimination.
Corporate Bond Funds: Invest at least 80% in AA+ or higher-rated corporate bonds, suitable for risk-averse investors seeking regular income and principal safety.
Credit Risk Funds: Invest a minimum of 65% in corporate bonds rated AA or below, offering higher yields with higher default risk.
Banking and PSU Funds: Invest at least 80% in debt instruments issued by banks, PSUs, and public financial institutions, providing a balance of yield, safety, and liquidity.
Gilt Funds: Invest in government securities with varying maturities, offering zero default risk.
Floater Funds: Invest at least 65% in floating-rate bonds, carrying less mark-to-market risk due to periodic coupon resets.
Dynamic Funds: Have no restrictions on security type or maturity profiles, managing portfolios flexibly based on market situations.
Conclusion
Debt funds come in various durations, ranging from as short as 1 day (overnight funds) to over 7 years (long duration funds). It’s crucial to choose based on your financial goals and how long you plan to invest. Many investors opt for debt funds to receive a steady income. Some smart investors allocate a part of their investment portfolio to debt for added stability. Whatever your reason, make sure to invest in line with your investment plan.
