Debt mutual funds are those investing in multiple securities on the basis of the credit ratings of the same. The credit rating indicates whether issuers of the security will be defaulting on disbursal of returns that they promised previously. Fund managers of debt funds ensure that investments are deployed in credit instruments which have high ratings. Debt funds investing in higher-rated instruments or securities have lower volatility and risk levels in comparison to those investing in low-rated securities.
Falling interest rate scenarios often spur fund managers to invest in long-term securities, while short-term securities are preferred in a scenario where interest rates are rising steadily. Debt mutual funds invest in securities that generate fixed interest including government securities, corporate bonds, treasury bills, money market instruments and commercial paper.
Types of debt mutual funds
Debt mutual funds can be classified into various types, depending on distinctly different parameters.
- Dynamic Bond Funds- These funds are true to their name, i.e. the composition of the portfolio is changed by the fund manager on the basis of interest rate changes. These funds have varying average maturity periods.
- Short & Ultra-Short Term- These funds usually invest in short maturity instruments. The tenors usually vary between 1-3 years. These are suitable for those with a more conservative approach towards managing market risks.
- Income- These are funds which majorly invest in debt securities that have extended maturities. These have higher levels of stability as compared to dynamic bond funds. Maturities usually range between 5-6 years on an average.
- Gilt- These funds make investments solely in government securities with high ratings and lower credit risks. The Government does not default on any loans taken by it in the form of debt securities. Hence, these funds are suitable for those with a higher aversion to market risks.
- Liquid- These funds invest in instruments that have maximum maturities of 91 days, making them almost free from any market risks. They are better options in comparison to savings accounts since they offer the same liquidity levels along with comparatively higher returns.
- Fixed Maturity- These funds function as closed-ended debt instruments, investing in fixed income securities, including government and corporate bonds. These have fixed durations when the money will be locked, ranging from a few months to even years. The investment is deployed in the initial offer period only.
- Credit Opportunities- These debt funds do not invest on the basis of the maturity period. Instead, they seek higher returns through holding onto lower-rated bonds which have higher rates of interest or by deciding on credit risks. The risk levels are relatively higher in this case.
As can be seen, there are various kinds of debt mutual funds that you can invest in. Make sure to consult professionals before signing on the dotted line and remember that a little homework goes a long way towards enabling the best decisions.