Primer on Debt Funds

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What are Debt Funds?

  • Debt funds are those funds which invest predominantly in various types of debt and money market securities like treasury bills, government securities, corporate bonds, commercial paper and certificate deposit.
  •  In general the debt securities have a fixed maturity date and pay a fixed rate of interest. The returns of debt mutual funds come from two avenues viz. interest income and capital appreciation/depreciation based on market value of the securities.
  • Every debt security is assigned a credit rating helping us to assess the capacity of issuer to repay the debt/loan.

Why Debt mutual funds

  • Debt funds offer investors to participate in debt markets of India with small ticket size. Variety of debt funds running different strategies are available.
  • By investing one debt scheme one holds ~30-40 different securities issued by different issuers like Government of India, State Government, Big Corporate and Banks. The choice of securities is made by professional Fund Managers having vast experience in the field of credit analysis, fixed income security analysis.
  • Usually the returns are not impacted by volatility in equity markets. Thus due to less volatility, debt mutual funds should bring stability to overall portfolio returns.
  • Liquidity need can be met through open-ended structures, although exit loads may be applicable in some cases.

Different types of Debt Funds

There is a wide range of debt mutual funds; suitable to invest depending upon investment horizon and capacity to take risk.

Other than the ones mentioned above there are close-ended debt funds. These include Fixed Income Plans (FMPs) having fixed tenure and interest rate.

Capital protection funds and multiple yield funds also form part of Debt mutual offerings.

Factors affecting returns

Some of the factors which may influence the performance of debt funds are listed below

  • Interest rate scenario-Domestic & Global markets
  • Inflation
  • Liquidity in money market
  • Monetary Policy stance/ Regulations by the RBI, Government of India
  • Growth in economy and overall macro-economic situation

Risks in Debt Mutual Funds

  • Credit risk – Impact due to credit migration or default risk
  • Interest rate risk – Impact on price of a bond due to changes in interest rate changes.
  • Liquidity risk – Inability of the fund to sell its investments and meet redemptions of investors due to poor market conditions 
  • Re-investment risk – Inability to reinvest cash flows (e.g., coupon payments) at a rate comparable to the current investment’s rate of return.

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