Debt Mutual Funds - Part 1

What is a Debt Mutual Fund ?

A debt mutual fund is a mutual fund that aims to provide regular and steady income to investors by investing in bonds, corporate debentures, government securities and money market instruments such as treasury bills, certificate of deposits, etc. They are ideal for investors who don’t want to take much risk but want steady returns comparable to that of Bank deposits. Many investors invest in debt mutual funds instead of bank deposits because of increased liquidity, lower taxes to be paid etc. However, they are not totally risk free. We will discuss the risks associated in a Debt Mutual Fund especially in an interest regime that is volatile or increasing or decreasing in forthcoming blogs. We will also discuss the benefits of a debt mutual fund and compare it with an FMP and Bank deposit.

Given below ate the different categories of Debt Mutual Funds that address the needs of different investors depending on the time frame of their investment

Liquid Funds or Money Market Funds
These are funds that aim to provide easy liquidity, preservation of capital and modest income. Returns on these schemes do not fluctuate sharply. They are ideal for individual investors that are looking to park their funds for short periods say less than a month and at the same time having better than bank deposit returns.

Short-term debt funds
These schemes invest in debt securities with tenures of less than six months.

Medium-term debt funds
These schemes invest in debt securities with tenures of six months to one year.

Long-term debt funds
These schemes invest in debt securities with tenures of more than one year.

Gilt mutual funds
Gilt funds invest only in government securities. Government securities don’t have credit or default risk and hence they are safer than say a certificate of deposit or money market instruments of a company rated as AAA. However, NAVs of gilt funds can fluctuate with the change in interest rates and we will discuss this in the future blogs. Even Gilt mutual funds are available in the above flavors of Liquid, Short-term, Medium-term and Long-term funds.

Floating rate funds
These mutual funds invest most of their money in instruments with floating interest rate i.e. the interest on these instruments will be linked to a market benchmark and will change if the benchmark increases or decrease. That makes them ideal investment in a rising interest rate scenario.

There are also other schemes such as Balanced funds and Monthly Income Plans where there is a big chunk of debt. They also have a huge chunk of equity and hence these are not pure debt funds and hence am not covering it.