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Debt Mutual Funds – Types, Interest Rates, Eligibility Criteria

The Mutual Fund Schemes are the archives of the trusts and the investor’s hard earned money. These Debt Mutual Funds are unique in its own way as they are organized and operated by the people whose loyalty and the interest lies outside the enterprise. There are different types of Mutual Funds that invest in various securities depending upon their investing strategy.

The Debt Mutual Funds mainly invests in the fixed income securities issued by the Government and the companies. These fixed income securities include the corporate bonds, government securities, treasury bills, money market instruments are many more debt securities. The Debt securities have a fixed maturity date and pay a fixed rate of interest.

The Returns of the Debt Mutual Funds comprises of two basic factors:

  • Interest Income
  • Capital Appreciation/ Depreciation in the value of the security due to the changes in the market dynamics.

When you purchase an equity instrument such as stock, you buy the ownership into the company to be a participant in its growth. But when you buy a debt instrument then give a loan to the issuing body. The Government based companies and the private sector companies issue the bills and bonds to get a loan for running their operations. The interest that you have earned in these debt securities is pre-decided along with a time period after which the debt security will mature. This is the reason why the Debt Mutual Funds are called as the “Fixed Income Securities” because you know that what you will get in the return out of them.

The Debt Fund Investments invests in the fixed income securities, and like the equity funds, they advance the returns by diversifying across the different types of securities. This allows the debt funds to earn a decent return, but one demerit is that there is no guarantee of returns. However, the Debt Funds can be expected in a predictable range which makes them safer avenues for consecutive investors.

Different Types of Securities that Debt Funds Invest In

The Debt Funds mainly invest in different securities and have different credit ratings. The securities credit ratings denote the risk element associated with the entity that is issuing the security. A higher credit rating means that the entity is more interested in paying the interest on the debt security as well as the principal amount upon the maturity. This is why it is more preferable for the debt mutual funds to invest in the higher-rated securities as it will be more volatile in nature than the low-rated securities.

Another factor that denotes the types of securities that the debt funds invest in is the maturity of that security. There are many debt funds that invest in the securities that mature at different time periods. The shorter the maturity period the less volatile the debt security.

Types of Debt Mutual Funds

There are different types of Debt Mutual Funds. The basic differentiating factor between the debt funds is the “Maturity period” of the instruments they invest. Below are the types of the Debt Mutual Funds where one can choose according to their requirement.

  1. Dynamic Bond Funds

The Dynamic Bond Funds are the types of funds that are not fixed at a certain point of the maturity period. They are quite fluctuating by nature it is because these funds take an interest rate calls and invest in the instruments which have a longer or shorter maturity period.

  1. Income Funds

The Income Funds take a call on the interest rates and they invest in the debt securities which will be having different maturity periods, but most often these income funds invest in the securities that have a longer maturity. Due to this feature, these funds are more stable than the dynamic bond funds. The average maturity of the income fund is around 5-6 years.

  1. Short-Term and Ultra-Short Term Debt Funds

These are the debt funds that invest in the instruments that have shorter maturity period which ranges from a year to 3 years. The Short-Term funds are ideal for the conservative investors as these funds will not get affected by the interest rate movements.

  1. Liquid Funds

The Liquid funds invest in the debt instruments which do not have a maturity period more than 91 days and because of this reason they are risk-free. They experience less negative returns and these are a good alternative option for savings bank account as they provide similar liquidity and higher returns. There are many Mutual Fund Companies that offer instant redemptions on the liquid fund investments through special debit cards.

  1. Gilt Funds

These funds only invest in the Government Securities. The Government is the high-rated securities and they do not come with the credit risk. It is because the Government is not going to default on the loan which it takes in the form of the debt instruments. This makes the gilt funds ideal for the risk-averse fixed income investors.

  1. Credit Opportunity Funds

These are newer debt funds. Other than the Debt Funds, the credit opportunities funds do not invest according to the maturities of the debt instruments. These funds earn higher returns by taking a call on the credit risks. These funds hold lower-rated bonds which come with higher interest rates. The credit opportunities funds are risky debt funds.

  1. Fixed Maturity Plans

The Fixed Maturity Plans are the close-end debt funds. These funds invest in the fixed income securities such as the corporate bonds and the Government securities. They have the lock-in period feature as well. All the Fixed maturity plans have a fixed horizon for which the money is locked in. the horizon can be for a month or for years. The investments in the Fixed Maturity Plans can be made only during the initial offer period. It is like a fixed deposit that will offer or deliver superior, tax-efficient returns but does not guarantee returns.

How do the Interest Rates Affect the Debt Mutual Funds

There are basically to rates of interests which are quite popular. Those are the repo-rate and the reverse repo rate. These rates are decided by the Reserve Bank of India. The RBI lends money to the commercial banks at the repo rate. There are quite a number of factors that result in the increase and decrease of the interest rates. These interest rates also determine the rate at which the institutions issue the bonds and other debt securities. The price of the fixed income securities is inversely proportional to the interest rates. If the interest rates increase then the bond yield goes down and the vice versa. This is why the debt funds tend to earn higher returns when the rate of interests falls or when expected to fall as the prices of the bonds go up.

Who are Eligible to Invest in the Debt Mutual Funds?

For the conservative investors, the Debt Mutual Funds are best option to choose. These are a sort of ideal investments for them. They are good alternatives to the fixed deposits. If the debt funds that deliver the returns that are in the range of the fixed deposit interest rates, then they are tax-efficient than the fixed deposits. The interest income that is earned from the fixed deposits are added to your income and the tax is charged as per the slab you fall under. The Short-term gains achieved from the debt funds are also added to the investor’s taxable income. If their holding period is more than 3 years then they become tax-efficient by nature. The long-term gains are taxed at 20% after indexation.

The debt funds are liquid by nature when compared to the fixed deposits. Where the fixed deposits come in lock-in period, the debt funds can be redeemed at any time. Partial redemptions can also be done from the debt funds.

Hence, these are the reasons the debt funds are recommended in place of the fixed deposits. And always keep in mind before investing that, the Debt Mutual Funds do not guarantee capital protection or fixed returns.