What Is Debt Fund? Return, Types, Benefits, How To Invest - DivineBring

Hello! Today, we will talk about the series on mutual funds, specifically about Debt Funds. Today, we will learn what a Debt Fund is and how we can invest in it. If you want to increase your money with good returns and also want to take less risk, choosing Debt Funds could be a good option for you.

In today’s times, there are many mutual funds available in the market, and one of them is the debt mutual fund. By investing in this, not only is your money secure, but you also get good returns. However, the scheme in which you invest in a debt fund determines your returns.

What is a Debt Fund?

When we talk about mutual funds, the term “Debt” refers to a loan. For example, if someone wants to build their own house, they take a loan from a bank and have to pay interest to the bank in return. Similarly, when any investor invests in a debt mutual fund, they also receive interest in return.

If we talk about why the government needs loans, sometimes the government introduces various schemes for which it requires funds. In such cases, the government takes loans by issuing Treasury Bills and Bonds. Treasury Bills are issued for less than one year, while Bonds are issued for a longer duration.

If we want to understand a debt fund in simple terms, we can think of it as investing in companies that provide loans to their customers. When investors invest in a debt fund, they receive interest directly. These companies can be of both government and private types

Note – It is predetermined in this that the money will be given at a certain percentage of interest, so it does not make any difference in the ups and downs of the stock market.

How Debt Funds Work

Many people think that when they invest in equity funds, the fund buys shares directly from companies. However, when investing in debt funds, how is our money invested? Well, when investors invest in mutual funds, they get company shares directly when investing in equity. On the other hand, those investing in debt funds don’t directly buy shares. Instead, they lend their money to financial institutions, governments, and corporations.

Registering with SEBI (Securities and Exchange Board of India) is mandatory for a debt fund company before commencing its operations, eliminating any risks in this regard. A crucial requirement for any debt mutual fund is that at least 65% of its funds must be invested in bonds or bank deposits. Government bonds, company bonds, corporate fixed deposits, and bank deposits fall under the investment portfolio of a debt mutual fund. The remaining funds are typically invested in equities, meaning shares.

Types of Debt Funds

When we talk about investing in debt mutual funds, there are 17 types of debt mutual funds, which are explained below:

1. Liquid Fund

In Liquid Funds, money is invested in instruments with a majority maturity period of no more than 91 days. Liquid funds are capable of providing investors with high liquidity. Their investment is primarily centered around treasury bills, commercial bonds, and certificates of deposits. Liquid debt funds serve as a better option for savings accounts and short-term investments.

2. Money Market Fund

Money market funds are investment funds that primarily invest in short-term, high-quality, liquid debt securities, such as Treasury bills, certificates of deposit, and commercial paper. These funds aim to provide investors with a safe and stable investment option while offering liquidity.

3. Dynamic Bond Fund

Dynamic bond funds invest in different maturity debt instruments based on the interest rate scenario. These funds are known as Dynamic Bond Funds. They are considered suitable for investors with moderate risk tolerance and an investment horizon of 3 to 5 years.

4. Corporate Bonds

Funds that invest a minimum of 80% of their total assets in the highest-rated corporate bonds are known as Corporate Bond Funds. These funds are considered better for investors who have a low–risk tolerance and prefer investing in high-quality corporate bonds.

5. Banking and PSU Fund

A Banking and PSU (Public Sector Undertaking) Fund is a type of mutual fund that primarily invests in debt instruments issued by banks and public sector undertakings (PSUs) or government-owned companies. These funds primarily focus on fixed-income securities issued by banks, financial institutions, and government-owned entities.

6. Gilt Fund

Funds that invest a minimum of 80% of their investments in government securities across different maturity periods are known as Government Securities Funds. These funds carry no credit risk, although they may have interest rate risk.

7. Gilt 10-Year Fund

When investments are made in gilt funds with a lock-in period of 10 years, they are referred to as 10-year Gilt Funds.

8. Credit Risk Fund

A Credit Risk Fund is a type of mutual fund or investment vehicle that primarily invests in debt securities with lower credit ratings, typically below investment grade. These funds target higher yields by investing in bonds issued by entities with a higher risk of default or credit deterioration.

9. Floater Debt Funds

A floater debt fund, also known as a floating rate fund, is a type of mutual fund or investment vehicle that primarily invests in debt securities with variable interest rates. Unlike traditional fixed-rate bonds, the interest rates on the securities held by floater debt funds adjust periodically based on changes in benchmark interest rates or other predetermined factors.

10. Overnight Fund

Funds that invest in overnight securities with a maturity of one day are called Overnight Funds. These funds are considered extremely safe as they have minimal credit risk and interest rate risk.

11. Ultra-Short Duration Fund

Funds that invest in money market instruments and debt securities in such a way that the scheme’s Macaulay duration falls between three to six months are categorized as Ultra Short Duration Funds.

12. Low Duration Fund

A low-duration debt fund is a type of investment that focuses on short-term fixed-income securities, typically with maturities ranging from six to twelve months. These funds aim to generate stable returns while minimizing the impact of interest rate fluctuations on their portfolio value.

13. Short Duration Fund

Funds that invest in money market instruments and debt securities in such a way that the scheme’s Macaulay duration falls between 1 to 3 years are categorized as Short Duration Funds.

14. Medium to Long Duration Fund

Funds that invest in money market instruments and debt securities in such a way that the scheme’s Macaulay duration falls between 4 to 7 years are categorized as Medium to Long Duration Funds.

15. Medium Duration Fund

Funds that invest in money market instruments and debt securities in such a way that the scheme’s Macaulay duration falls between 3 to 4 years are categorized as Medium Duration Funds.

16. Long Duration Fund

Funds that invest in money market instruments and debt securities in such a way that the scheme’s Macaulay duration exceeds 7 years are categorized as Long Duration Funds.

17. FMP Fund

A Fixed Maturity Plan (FMP) Fund is a type of close-ended debt mutual fund with a fixed maturity period, typically investing in fixed-income securities to generate stable returns until the predetermined maturity date.

The Benefits of Investing in Debt Funds

Adding Debt Mutual funds to our portfolios brings diversity, and it helps insulate our portfolios from the fluctuations in the stock market.
Debt funds can offer good returns to investors with moderate risk and provide a way to manage risk beyond other investment options.
In debt funds, you can get a better and more stable return compared to bank fixed deposits.
Debt mutual funds can also serve as a good option for emergency funds, as keeping some money in a highly liquid emergency fund in the form of debt funds can be a prudent choice compared to fixed deposits.

Debt Mutual Fund Disadvantages

Low returns: Sometimes debt funds may not provide satisfactory returns to investors, especially when the interest rates are low in the market and the economy is not performing well. In such situations, they may offer returns lower than fixed deposits.
If you invest in debt funds through mutual funds, the mutual fund house charges some expense ratio, resulting in slightly lower returns on the debt funds.
Credit risk: Sometimes, there is a risk that the money lent by us, including the principal and interest rate, may not be repaid. This can result in direct losses for investors. The likelihood of this happening increases when financial institutions invest in bonds with legal quality.
Liquidity risk: Many times, due to a high number of redemption requests, fund managers may face liquidity issues.
In debt funds, one disadvantage is that you do not benefit from sudden market ups and downs, as you would in equity funds.

Debt Mutual Funds Taxation

In Debt Mutual Funds, there are two types of taxes – one is Short-Term Capital Gains Tax, and the other is Long-Term Capital Gains Tax. Short-Term Capital Gains Tax is applicable when we withdraw our invested amount in the Debt Fund within the first 3 years. On the other hand, a Long-Term Capital Gains Tax is imposed when we withdraw it after 3 years.

If you invest your money in a Debt Fund for less than 3 years, you are required to pay taxes according to your income tax slab. It’s noteworthy that the short-term duration for Debt Funds is 3 years, whereas, for equity funds, this duration is 1 year.

If you withdraw your invested amount after 3 years, you are liable to pay Long-Term Capital Gains Tax. After indexation, this tax becomes applicable at a rate of 20 percent. Additionally, there may be applicable cess and surcharge charges on this amount.

Debt Fund Charges

In debt mutual funds, there can be three types of charges, and these charges can vary in each debt fund:

Expense Ratio: It includes fees charged for managing and operating the fund.
Exit Load: This is a fee that investors have to pay when they withdraw their investment, and it is a type of charge that can incentivize investors to close their investments.
Stamp Duty: Investors have to pay it when investing or closing an investment, and it is based on a specified amount

How to invest in debt funds?

Firstly, you should have a demat account.
After that, based on your convenience, choose a debt fund.
Once you have chosen the fund, you have two options: SIP and One Time/Lumpsum.
Choose the option that suits you best and proceed with the investment.

Note – In SIP, you need to deposit your fixed SIP amount on a specific date every month, and if you are unable to deposit it on time, you do not have to pay any penalty. On the other hand, LUMPSUM means making a one-time investment where you need to invest your entire amount at once.

Is it right to invest in a Debt Fund?

Investing in debt funds can prove to be a suitable option because debt funds are not as susceptible to the market’s ups and downs. Even if the market experiences a crash, you do not have to bear significant losses with debt funds.

Who should invest in debt mutual funds?

There are so many funds available in the market, to the extent that even in mutual funds, numerous funds are present. This leads us to consider in our minds whether debt funds could be better for certain investors. Debt funds might be a better option for investors who prefer taking less risk. Debt funds typically invest in several securities to ensure stable and balanced returns. However, there is no guarantee for all these, and performance generally falls within the expected range.

Debt Mutual Fund – FAQs

What is the difference between a Private Debt Fund and a Government Debt Fund?

When you talk about debt funds, people often wonder about the difference between private debt funds and government debt funds. Government debt funds are created when the government presents its annual budget, and the money allocated in it is raised by issuing bonds to the public. This is known as government debt funds. On the other hand, private companies also raise funds by issuing bonds to enhance their business. These bonds are referred to as corporate bonds, and the investment made in corporate bonds constitutes private debt funds.

Are there charges for investing in Debt Fund?

Yes, there is a recurring ratio charge on investing in debt funds which can be up to 1 percent.

What things should be kept in mind while investing in Debt Fund?

When we invest in any type of debt fund, there are certain things we should keep in mind to avoid losses:

Firstly, one should choose a good fund.
Pay attention to the past performance of that fund.
Whenever buying any kind of bond, it should be thoroughly examined.
Before investing, one must calculate the recurring ratio charges that will be applied.

What is the difference between a Debt Mutual Fund and an Equity Mutual Fund?

The main difference between debt and equity mutual funds is that equity mutual funds directly invest in shares, representing ownership in a company, which can be quite risky. On the other hand, debt mutual funds do not directly invest in company shares; they invest in instruments like government bonds, corporate bonds, etc., which are generally considered less risky.

What is the difference between a Bond and a Debt Fund?

Bonds issued by organizations, whether corporate or government entities, come with pre-determined terms. In contrast, debt mutual funds invest in debt instruments such as bonds, debentures, commercial papers, and other fixed-income securities. Investing in debt mutual funds is an indirect way of investing in bonds. For fixed-income needs, investing in debt mutual funds has generally been considered superior to investing directly in bonds due to the professional management and diversification they offer.

Can I withdraw money from the Debt Mutual Fund at any time?

Yes, you can withdraw your invested money from a Debt Mutual Fund according to your preference. Just keep in mind that when you are withdrawing the money, you need to consider the applicable taxes.

How much annual return is given in a Debt Mutual Fund?

The annual return on debt funds is around 9 percent.

Which is the debt fund scheme giving the best returns?

In this article, a table of Debt Funds that have delivered excellent returns over the past few years has been provided. You can choose from this table for your investment.

What is a Venture Debt Fund?

Venture Debt Funds are a type of investment fund that lends money to new startups and well-established companies, without investing in equity. Venture debt is an attractive option for new startups and companies because it is often more easily accessible than traditional bank loans. Unlike traditional loans, venture debt funds provide capital to companies without requiring them to issue equity, making it an appealing financing alternative for startups and growing businesses.

What are Private Debt Funds?

Private companies borrow money to fulfill their goals and expand their businesses. The bonds issued by these companies are referred to as corporate bonds. Therefore, the investment made in corporate bonds falls under the category of private debt funds.

What is Yield in Debt Funds?/What is Yield Debt Fund?

The total rate of return earned by a bond when it pays all interest and repays the principal at maturity is known as the Yield to Maturity (YTM). YTM is the internal rate of return (IRR) of a bond, considering it is held until maturity. It is mandatory to hold the bond until maturity to calculate the YTM accurately.

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