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Types of Debt Mutual Funds and Their Features, Risks, and Suitability

Types of Debt Mutual Funds and Their Features, Risks, and Suitability

For investors seeking high investment stability with moderate returns, debt mutual funds have emerged as a viable alternative. Debt mutual funds offer low risk by investing in fixed-income securities like corporate bonds, money market instruments, government bonds, and more.

With an aim to offer inflation-beating returns, these mutual funds earn decent returns through capital appreciation and interest. Debt mutual funds are also the biggest mutual fund category, offering investors the choice to invest from 14 different sub-categories based on their investment goals and risk appetite.

Read on to know the various types of debt mutual funds, along with their features, risk, and suitability.

Types of debt mutual funds

1. Overnight funds

Overnight funds typically invest in money market instruments having an overnight maturity of 1 day. These funds are backed by government securities, so they have little to no risk. This makes them a great option for risk-averse investors looking to park their funds for a few days. However, overnight funds are more suitable for liquidity and convenience rather than high returns.

2. Liquid funds

Liquid funds invest in debt instruments like treasury bills, commercial paper, and certificates of deposits with maturities of less than 91 days. Since these funds can be converted into cash easily, they are best suited for investors looking to invest their extra funds for a few days and gain stable and more interest income than savings bank account.

3. Ultra-short duration funds

If you have an investment horizon of 3-6 months, ultra-short-duration funds are an investment worth exploring. They offer relatively higher yields than liquid funds and feature low risk, making them a viable option.

4. Low-duration funds

Investors who dont mind taking a little risk for reasonable returns can invest in low-duration funds. These funds invest in securities with a maturity of 6-12 months to a year and generate decent returns at moderate risk.

5. Money market funds

Money market funds generate reasonable returns from interest income while also giving you the potential for capital gains. They invest in securities with a maturity of up to 1 year, so they carry low interest rate risk for the investor.

6. Short-duration funds

Short-duration funds invest in short-term debt, money market securities, and government securities for a period of 1-3 years. These funds have a low to moderate interest rate risk and perform best when interest rates are high.

7. Banking and PSU funds

These funds invest at least 80% of their corpus in debt securities issued by PSUs, banks, and public financial institutions. Such funds are apt for investors with a moderate risk appetite seeking reasonable returns, safety, and liquidity.

8. Corporate bond funds

Risk-averse investors seeking regular income and security of their principal amount can consider corporate bond funds. These funds invest at least 80% of their corpus in AA+ or higher-rated corporate bonds, which makes them a safe investment option.

9. Dynamic bond funds

Dynamic funds are one of the most versatile debt fund schemes. These funds carry no restrictions on the type of security or maturity profile while investing funds. Fund managers manage these funds flexibly based on the market situation, so they are suitable for investors with moderate to high-risk appetite.

10. Credit risk funds

Credit risk funds are suitable for investors who are willing to take risks as they invest a minimum of 65% of their total assets in corporate bonds rated AA or below. However, this also helps them generate higher yields than conservative funds.

11. Fixed-maturity plans

Fixed maturity plans (FMPs) are closed-end debt fund schemes that have a fixed lock-in period. FMPs typically invest in high-rated, low-risk instruments and are held passively till they are redeemed at the end of maturity. Since these funds have a lock-in period, they aren’t affected by changing interest rates in the market, which eliminates risk.

12. Medium, medium to long, and long-duration funds

These funds invest in short to long-term debt securities under the Government, public, and private sectors. Typically, the maturity period ranges from 3-4 years for medium-duration funds, 4-7 years for medium to long, and 7+ years for long-duration funds.

While they generate decent returns, they also feature a fairly high interest rate risk.

13. Gilt funds

Gilt funds only invest in government-issued debt securities of varying maturity. Since they are government-backed, there is no credit risk. The maturity period           ranges from short to long-term.

14. Floater Funds

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

15. Target Maturity Funds

These are passive debt funds with predefined maturity date. These funds follow roll-down investment strategy where fund manager builds a portfolio of bonds of a certain tenure and then holds these bonds to maturity. As these funds carry comparatively lower interest rate risk and provide more predictive & stable returns.

In the end

If you’re looking for diversification, liquidity, and the potential for steady returns with your investments, debt funds are an excellent choice. However, before investing, remember to understand the risks and choose the right type of debt fund that aligns with your investment goals.

Ready to start your investment journey? Get in touch with us at Tata Capital Wealth. Tata Capital offers a secure platform for investors to explore various schemes, monitor their investments, and make sound decisions.

Check out our website for more details.

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