What are 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.

• 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.

• 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.