What Are Debt Funds, Types, Benefits? (2023)

A debt fund is a mutual fund scheme that invests in debt instruments like Corporate and Government Bonds, corporate debt securities, and money market instruments,etc. There are different types of debt funds to suit investors with varying risk-return profiles, investment horizons, and financial goals. Debt funds invest in all kinds of debt, such as treasury-bills, government securities, commercial paper, certificates of deposits, money market instruments, securitized debt, and corporate bonds. It is also known as Fixed Income Funds or Bond Funds.
The key difference between a debt fund and an equity fund is that they invest in different asset classes. Equity funds invest 65% or more of their assets into equity and equity-linked products, while debt funds hold mainly bonds and cash assets. Remember that the value of an investment depends on the prices of the securities that make up the investment. Since bond prices tend to be less volatile than stock prices, debt fund values are more stable than the value of equity funds. In other words, debt funds are considered to be less risky, especially when held for short periods of time.

  1. Types of Debt Funds
  2. Why invest in debt funds?
  3. Top Performing Debt Mutual Fund
  4. Summary

1. Types of Debt Funds

Here are the different types of debt funds:

  • Overnight Funds:

    Overnight Funds invest in securities having a maturity of 1 day, typically money market instruments. These funds aim to provide liquidity and convenience, rather than high returns. They are suitable for investors (mainly corporate treasuries) looking to park funds for a very short period.

  • Liquid Funds:

    Liquid Funds invest in debt securities with less than 91 days to maturity. They are suitable for investors who want to park temporary cash surpluses for a few days, as they provide steady returns with minimum NAV volatility.

    (Video) What are Debt Mutual Funds? | Types & Benefits of Investing in Debt Funds

  • Ultra-short Duration Funds:

    Ultra-short Duration Funds are suitable for investors who have an investment horizon of at least 3 months. These funds earn slightly higher yields than liquid funds and are considered to be a low risk investment. Some ultra-short duration funds may invest in lower-rated bonds to push up their yields.

  • Low Duration Funds:

    Low Duration Funds are moderately risky and provide reasonable returns. They are useful for those looking to invest for around 6 months to one year. Their portfolio may include bonds with a weaker credit rating to kick up yields.

  • Money Market Funds:

    Money Market Funds invest in debt instruments with maturity upto one year. They aim to generate returns from interest income, while their slightly longer duration offers some scope for capital gains.

  • Short Duration Funds:

    Short Duration Funds invest in a judicious combination of short and long-term debt, as well as across credit ratings. These funds are recommended for investment horizons of 1-3 years. They usually earn higher returns than liquid and ultra-short duration funds, but also show more NAV fluctuations.

  • Medium, Medium to Long and Long Duration Funds:

    Under normal situations, the portfolio duration of a medium duration fund has to be between 3-4 years, medium-to-long duration fund between 4-7 years, and long duration funds greater than 7 years. These funds invest in short and long-term debt securities of the Government, public sector and private sector companies. They tend to do well when interest rates are falling but underperform when rates are rising. Thus, they carry fairly high interest rate risk.

  • Fixed Maturity Plans (FMPs):

    Fixed Maturity Plans (FMPs) are closed-end funds that invest in debt securities with maturities that match the term of the scheme. FMPs typically invest in low-risk, highly-rated debt and hold passively until maturity, when the securities are redeemed and paid out to investors. The main advantage is that the FMP structure eliminates interest rate risk and enables investors to lock in interest rates. The main drawback is that though FMPs are listed, liquidity tends to be low.

  • Corporate Bond Funds:

    Corporate Bond Funds must invest at least 80% of the portfolio in AA+ or higher rated corporate bonds. Such funds are appropriate for risk-averse investors looking for regular income and safety of principal.

    (Video) #WATCH | What Are Debt Funds? What Are The Key Advantages?

  • Credit Risk Funds:

    Credit Risk Funds invest a minimum of 65% of total assets in corporate bonds rated AA or below. That is why they usually generate higher yields as compared to the more conservative corporate bond funds. Investors who are willing to take on higher default risk may consider investing in credit risk funds.

  • Banking and PSU Funds:

    Banking and PSU Funds invest at least 80% of total asset in debt instruments issued by banks, PSUs, and public financial institutions. This is a moderate risk product that seeks to balance yield, safety and liquidity.

  • Gilt Funds:

    Gilt Funds invest in government securities of varying maturities. They can be short or long duration funds, depending on the maturity of their portfolio. Gilt funds have zero default risk, because they invest in safe g-secs.

  • Gilt Funds with 10-year constant duration:

    Gilt Funds with 10-year constant duration invest at least 80% of total assets in g-secs and maintain a constant portfolio duration of 10 years.

  • Floater Funds:

    Floater Funds invest at least 65% of their assets in floating rate bonds. These funds carry less MTM risk because the coupons on their floating rate debt holdings are reset periodically based on market rates.

  • Dynamic Funds:

    Dynamic Funds have no restrictions on security type or maturity profiles for investment. The best performing dynamic funds manage their portfolios dynamically and flexibly according to market situations.

2. Why invest in debt funds?

Debt funds offer many benefits, especially to retail investors, or to investors who have traditionally kept their money in bank deposits.

  • Access to Professional Expertise and Market Returns:

    Investing in a debt fund offers the opportunity to earn interest as well capital gains from debt. It allows retail investors to access money markets or wholesale debt markets- segments in which they cannot directly invest.

  • Lowers Portfolio Risk:

    Since debt funds are less risky than equity funds, a strategic allocation to the best performing debt funds reduces risk and brings stability to an investment portfolio. Tactical investments in debt funds are useful to take advantage of temporary yield opportunities.

  • Range of investment options:

    Debt funds are available along the entire spectrum of maturity and credit risk. Shorter duration funds generate regular and stable income. Longer duration funds earn from interest income as well as capital gains, and suit investors who can take on higher NAV volatility. Overnight funds, liquid funds, corporate bond funds and low duration funds tend to invest in the safest debt products. Ultra-short and short duration funds may be structured to take on credit risk to provide higher returns.

  • Liquidity:

    Debt funds are very liquid, and can be redeemed easily, usually within one or two working days of placing the redemption request. Unlike bank fixed deposits or recurring deposits, there is no lock-in period. While a few funds may impose a small exit load for early withdrawal, in general, there are no penalties when a mutual fund investment is withdrawn.

  • Low Cost Investment:

    According the SEBI norms, the total expense ratio of a debt fund cannot exceed 2% of Assets under Management. Among debt funds, overnight and liquid funds have very low expense ratios, while dynamic and long-term funds charge higher expense ratios.

(Video) What is Debt Mutual Fund? What are the Types of Debt Mutual Funds & its Benefits | HDFC securities

3. Top Performing Debt Mutual Fund

Fund Name 3-year Return (%)* 5-year Return (%)*
Aditya Birla Sun Life Medium Term Direct Plan-Growth 10.90% 8.35% Invest
7.30% 5.35% Invest
UTI Bond Fund Direct-Growth 6.52% 3.52% Invest
Nippon India Ultra Short Duration Fund Direct-Growth 6.67% 5.89% Invest
ICICI Prudential Ultra Short Term Fund Direct-Growth 5.72% 6.70% Invest

*Last updated as on 11th Oct 2022

(Video) Equity vs Debt funds | Equity or Debt mutual funds | Types of mutual funds

4. Summary

  • Debt funds are mutual funds that invest in debt securities.
  • There are many types of debt funds that invest across the maturity and credit risk spectrum.
  • Debt funds earn accrual income from coupons and capital gains/losses as NAV is marked up or down due to changing market yields.
  • How much a fund earns from interest and how much from capital gains depends on the type of bonds in its portfolio.
  • Funds with lower average maturity or duration earn mainly from interest payments. Funds with a longer average maturity earn from interest coupons as well as capital gains.
  • Funds can invest in lower rated debt to push up yields, but that also increases credit risk. They can increase average maturity by increasing holdings of long-term debt, but that increases the interest rate risk.
  • Debt funds offer a low-cost and convenient method of taking debt exposure. They offer several advantages over traditional bank deposits as well as direct bond investment.
  • Debt funds bring stability to an investment portfolio. They are useful for investors seeking regular and steady income, to facilitate goal-based financial planning and to earn alphas from interest rate changes.

Don't miss out!

Join our newsletter to stay in the loop

(Video) Debt Funds: All You Need To Know | Personal Finance for Beginners

FAQs

Which type of debt fund is best? ›

Two fund categories, Overnight Funds and Liquid Funds fall in this category. These are the safest funds in the debt category with negligible interest or credit risk. In these funds, safety and liquidity take the highest priority with returns being an outcome of the first two factors.

What are the 4 main types of funds and what are their functions? ›

Generally speaking, there are four broad types of mutual funds: those that invest in stocks (equity funds), bonds (fixed-income funds), short-term debt (money market funds) or both stocks and bonds (balanced or hybrid funds). Every mutual fund is designed to spread around risk while capturing wider market gains.

What are 3 types of funds? ›

A fund is a pool of money set aside for a specific purpose. The pool of money in a fund is often invested and professionally managed in order to generate returns for its investors. Some common types of funds include pension funds, insurance funds, foundations, and endowments.

What are the 2 main types of debt? ›

Generally, there are two main types of debt: secured and unsecured. Within those types, you'll see revolving and installment debt. Aside from the fact that you owe money, these types of debt are different. For instance, your mortgage is an example of secured debt, while an example of unsecured debt is your credit card.

What are the 3 classifications of debt investments? ›

Debt securities should be classified into one of three categories at acquisition: Held to maturity. Available for sale. Trading.

Which type of debt fund is safest? ›

If you want to invest in debt funds that carry barely any credit risk, gilt funds are perhaps your best bet. These debt funds invest mainly in government securities (G-Secs) like government bonds. And since these assets are backed by the government's sovereign guarantee, the risk of default is practically zero.

Are debt funds risk free? ›

It's true that Debt Funds are less risky compared to Equity Funds but that doesn't mean Debt Funds guarantee that your money will never face any loss. Debt funds invest in debt and money market securities that are prone to different kind of risk factors as compared to equity funds that invest in stock market.

Why it is called debt fund? ›

what is debt fund? A debt fund is a mutual fund scheme that invests in fixed income instruments, such as Corporate and Government Bonds, corporate debt securities, and money market instruments etc. that offer capital appreciation. Debt funds are also referred to as Income Funds or Bond Funds.

What are the 5 types of fund balances? ›

The new fund balance classifications will indicate the level of constraints placed upon how resources can be spent and identify the sources of those constraints. Constraints are broken down into five different classifications: nonspendable, restricted, committed, assigned, and unassigned.

What are the six categories of funds? ›

There are six common types of mutual funds:
  • Money Market Funds. Money market funds invest in short-term fixed-income securities. ...
  • Fixed Income Funds. Fixed income funds buy investments that pay a fixed rate of return. ...
  • Equity Funds. Equity funds invest in stocks. ...
  • Balanced Funds. ...
  • Index Funds. ...
  • Specialty Funds.
27 Oct 2022

What are the 4 types of investments? ›

There are four main investment types, or asset classes, that you can choose from, each with distinct characteristics, risks and benefits.
  • Growth investments. ...
  • Shares. ...
  • Property. ...
  • Defensive investments. ...
  • Cash. ...
  • Fixed interest.

What are the 4 types of mutual funds? ›

What types of mutual funds are there? Most mutual funds fall into one of four main categories – money market funds, bond funds, stock funds, and target date funds. Each type has different features, risks, and rewards.

What are the top 3 mutual funds? ›

Top 25 Mutual Funds
RankSymbolFund Name
1VSMPXVanguard Total Stock Market Index Fund;Institutional Plus
2VFIAXVanguard 500 Index Fund;Admiral
3FXAIXFidelity 500 Index Fund
4VTSAXVanguard Total Stock Market Index Fund;Admiral
21 more rows

What are the 2 most important sources of funds? ›

Equity shares and retained earnings are the two important sources from where owner's funds can be obtained. Borrowed funds refer to the funds raised with the help of loans or borrowings. This is the most common type of source of funds and is used the majority of the time.

What are the 4 types of debt? ›

Debt can be classified into four main categories: secured, unsecured, revolving, or mortgaged. Corporations issue debt in the form of bonds to raise capital.

What is the most common type of debt? ›

1. Mortgage debt. Total debt: $11.18 trillion (70.6% of all debt in the U.S.)

What are the top 5 causes of debt? ›

What are the main causes of debt?
  • Declining health and medical expenses. ...
  • Job loss. ...
  • Education and student debt. ...
  • Living beyond your means. ...
  • Not having a budget. ...
  • Lack of an emergency fund or savings. ...
  • Having children. ...
  • Failed business and business expenses. Starting your own business can be a very rewarding and successful experience.

What are the 4 types of financial bonds? ›

Issuers of Bonds
  • Corporate bonds are issued by companies. ...
  • Municipal bonds are issued by states and municipalities. ...
  • Government (sovereign) bonds such as those issued by the U.S. Treasury. ...
  • Agency bonds are those issued by government-affiliated organizations such as Fannie Mae or Freddie Mac.

What are the 3 biggest strategies for paying down debt? ›

In general, there are three debt repayment strategies that can help people pay down or pay off debt more efficiently. Pay the smallest debt as fast as possible. Pay minimums on all other debt. Then pay that extra toward the next largest debt.

Which debt fund is low risk? ›

Liquid funds, ultra-short-term funds, gilt funds, dynamic bond funds are some of the types of low risk funds. Therefore, depending on your investment objective and goal, you can choose a suitable scheme for investment.

Which debt fund is best for long term? ›

  • Nippon India Prime Debt Fund.
  • SBI Magnum Gilt Fund.
  • ICICI Prudential Corporate Bond Fund.
  • Aditya Birla Sun Life Corporate Bond Fund.
  • Kotak Corporate Bond Fund Standard.
  • Sundaram Corporate Bond Fund.
  • HDFC Corporate Bond Fund.
  • Franklin India Corporate Debt Fund.
7 days ago

Which is better FD or debt fund? ›

An FD is more secure than a debt mutual fund, and market fluctuations do not impact the interest rate. A debt mutual fund is good for investors who are okay with the risk factor.

Who should invest in debt funds? ›

Debt fund returns often fall in a predictable range. This makes them safer avenues for conservative investors. They are also suitable for people with both short-term and medium-term investment horizons. Short-term ranges from three months to one year, while medium-term ranges from three years to five years.

Is SIP in debt funds good? ›

All debt funds are not suitable for SIPs. You need to have long investment tenures because SIP returns are highest in the long term due to the power of compounding. Debt funds which have higher volatility and need long investment horizons should be considered for SIPs.

Why debt funds are safe? ›

Debt funds put money in fixed income securities. It is safer as compared to equity funds which invest in stocks and are subject to the volatility of the stock markets. You may diversify your portfolio with debt funds. The safety of debt funds depends on the type of debt funds and the interest rate fluctuations.

How do debt funds work? ›

Debt mutual are a type of mutual fund that generate returns from their investors' money by investing in bonds or deposits of various kinds. In short, they lend money and earn interest on the money they have lent. This interest that they earn forms the basis for the returns that debt funds generate for investors.

How does debt fund return? ›

Debt Funds invest our money in interest-bearing securities like bonds and money market instruments that promise to pay regular interest. These interest payments are received by the fund which in turn contributes to the total return we, as investors of the fund, earn.

What are the 11 fund types? ›

Governmental funds include the following:
  • General Fund. A general fund is the chief operating fund for the entire government. ...
  • Special Revenue Funds. ...
  • Debt Service Fund. ...
  • Capital Projects Fund. ...
  • Permanent Fund. ...
  • Enterprise Fund. ...
  • Internal Service Fund.
12 Jan 2022

How many types of funds are there? ›

There are four types of MF schemes, corresponding to four basic asset types. The four asset types are equities, fixed income, commodities, or a combination of the three.

What are the 7 types of equity funding? ›

Here are seven types of equity financing for start-up or growing companies.
  • 01 of 07. Initial Public Offering. ...
  • 02 of 07. Small Business Investment Companies. ...
  • 03 of 07. Angel Investors for Equity Financing. ...
  • 04 of 07. Mezzanine Financing. ...
  • 05 of 07. Venture Capital. ...
  • 06 of 07. Royalty Financing. ...
  • 07 of 07. Equity Crowdfunding.
16 Jun 2020

What are Category 2 funds? ›

Category II: Funds investing in various equity securities and debt securities come under this category. All those funds that are not described under category I and III by SEBI, fall under category II. No incentive or concession is given by the government on investment in these funds.

Which category of mutual fund is best? ›

Get App / Open App
Category1Y2Y
Equity: Large & Mid Cap Fund Equity: Large & Mid Cap Fund7.7%23.8%
Equity: Mid Cap Fund Equity: Mid Cap Fund7.6%26.2%
Equity: Small Cap Fund Equity: Small Cap Fund8.5%27.2%
Equity: ELSS10.6%21.4%
29 more rows

What are the Top 5 Ways to invest? ›

12 best investments right now
  • High-yield savings accounts.
  • Certificates of deposit (CDs)
  • Money market funds.
  • Government bonds.
  • Corporate bonds.
  • Mutual funds.
  • Index funds.
  • Exchange-traded funds (ETFs)
27 Sept 2022

What are 3 mutual fund benefits? ›

Why invest in mutual funds?
  • Diversification. Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. ...
  • Low cost. ...
  • Convenience. ...
  • Professional management.

What is Bluechip fund? ›

A blue-chip fund is an equity scheme which offers its investors a portfolio of stocks that offer solid and stable financial performance.

What are 5 star mutual funds? ›

Constituents
  • Quant Tax Plan Direct-G.
  • Parag Parikh Tax Saver Fund Direct-G.
  • Quant Tax Plan-G.
  • Parag Parikh Tax Saver Fund Reg-G.
  • Canara Robeco Equity Tax Saver Direct-G.
  • Mirae Asset Tax Saver Direct-G.
  • Canara Robeco Equity Tax Saver Reg-G.
  • Mirae Asset Tax Saver Reg-G.

What is the safest type of mutual fund? ›

Money market mutual funds = lowest returns, lowest risk

They are considered one of the safest investments you can make. Money market funds are used by investors who want to protect their retirement savings but still earn some interest — often between 1% and 3% a year.

Which MF has highest return? ›

List of High Risk & High Returns in India Ranked by Last 5 Year Returns
  • PGIM India Midcap Opportunities Fund. Consistency. ...
  • Nippon India Small Cap. Consistency. ...
  • Kotak Small Cap Fund. Consistency. ...
  • Axis Small Cap Fund. Consistency. ...
  • ICICI Prudential Smallcap Fund. ...
  • SBI Small Cap Fund. ...
  • DSP Small Cap Fund. ...
  • Edelweiss Mid Cap Fund.

Which mutual fund is best for 5 years? ›

Let's discuss these best sip plans for 5 years in Debt MF in detail below:
  • HDFC Short Term Debt Fund. This is a short duration fund, moderately low-risk debt mutual fund. ...
  • Aditya Birla Sun Life Savings Fund. ...
  • SBI Magnum Medium Duration Fund. ...
  • Nippon India Low Duration Fund. ...
  • L&T Low Duration Fund.

What is the best funding source? ›

Here's an overview of seven typical sources of financing for start-ups:
  1. Personal investment. When starting a business, your first investor should be yourself—either with your own cash or with collateral on your assets. ...
  2. Love money. ...
  3. Venture capital. ...
  4. Angels. ...
  5. Business incubators. ...
  6. Government grants and subsidies. ...
  7. Bank loans.

What are the 4 sources of capital? ›

She suggests that there are in fact 4 sources of capital: equity, debt, grants and sales/revenue. There are 3 types of equity for funding operations: Public Equity, External Private Equity and Internal Equity. Public equity or securities include IPOs and crowdfunding efforts.

What are the four types of debt? ›

Debt can be classified into four main categories: secured, unsecured, revolving, or mortgaged. Corporations issue debt in the form of bonds to raise capital.

What are the four types of debt financing? ›

Debt Financing Options
  • Bank loan. A common form of debt financing is a bank loan. ...
  • Bond issues. Another form of debt financing is bond issues. ...
  • Family and credit card loans. Other means of debt financing include taking loans from family and friends and borrowing through a credit card.
17 Oct 2022

What are the four main types of debt securities? ›

Common types of debt securities include commercial paper, corporate bonds, government bonds, municipal bonds, and treasury bills/bonds.

What are the five debts? ›

Hindu scriptures say that every human being is born into five important debts that are Deva Rin, Rishi Rin, PitraRin, NriRin, BhutaRin and one has to repay these Karmic Debts to follow the path of DHARM in their lifetime.

How does debt funding work? ›

Debt comes in many forms but generally involves borrowing a sum of money, which is often secured against a tangible asset. The debt is repaid with interest at an agreed future date. Ideally your business should have a financial track record to secure debt.

What are the three components of debt? ›

The Three Debt Types: About Priority, Secured, and Unsecured Debts
  • Understanding the three classes of debt will help you figure out how bankruptcy works. ...
  • With secured debts, the money you owe is secured by collateral.
14 Mar 2018

Videos

1. How to select debt funds | Top 5 debt funds| All about debt mutual funds
(Mutual Funds at Groww)
2. Benefits of Debt Fund, Types of Debt Funds and Which One Should You Invest In? Expert Advise
(Moneyfront)
3. Debt Funds vs Equity Funds Explained | Financial Education
(Exencial Wealth Advisors)
4. What are Debt Funds: Types of Debt Fund and Who should invest in Debt Funds - Mutual Funds Talks
(Mutual Funds Talks By 5paisa)
5. WHAT IS DEBT MUTUAL FUNDS । PORTFOLIO PROTECTOR । DEBT FUNDS TYPES AND BENEFITS.
(BACHAT GYAN)
6. Types of Mutual funds in tamil
(ASN)
Top Articles
Latest Posts
Article information

Author: Greg O'Connell

Last Updated: 01/31/2023

Views: 5799

Rating: 4.1 / 5 (62 voted)

Reviews: 93% of readers found this page helpful

Author information

Name: Greg O'Connell

Birthday: 1992-01-10

Address: Suite 517 2436 Jefferey Pass, Shanitaside, UT 27519

Phone: +2614651609714

Job: Education Developer

Hobby: Cooking, Gambling, Pottery, Shooting, Baseball, Singing, Snowboarding

Introduction: My name is Greg O'Connell, I am a delightful, colorful, talented, kind, lively, modern, tender person who loves writing and wants to share my knowledge and understanding with you.