Basic of Debt Mutual Funds

🔹 What is a debt mutual fund?

The scheme corpus is invested in various fixed-income securities, such as treasury bills, commercial papers, government bonds, corporate bonds, and more. These investments have a fixed maturity date and an assured rate of interest. Because the returns are not related to market movements, debt funds are suitable for investors with a low-risk appetite.

🔹 How do debt funds work?

These types of funds generate returns by investing the corpus in fixed-income securities. These bonds and other instruments earn interest on the capital investment, which determines the investors' returns. The chosen debt instruments have credit ratings that allow investors to understand the potential default on the principal and interest. The fund managers and their teams use these credit ratings to choose the instruments with the lowest default risk.
Fund managers choose the instruments based on several factors. They may assume some calculated risk by choosing a low-quality debt investment to earn higher returns. Fund managers may invest in long-term or short-term instruments based on the interest rate scenario.

Types of debt funds

🔹 Liquid Funds

These are highly liquid and invest in instruments that have a maximum maturity of 91 days. Liquid funds are the least risky type of mutual fund schemes.

🔹 Short, medium, and long-term funds

Maturity of short-term funds is between one and three years and is appropriate for investors with a low-risk appetite. The prices of short-term debt funds are not impacted by changes in the market interest rates.

Medium-term debt funds have a maturity of three to five years and are comparatively riskier due to the longer duration.

Mutual fund schemes with a maturity exceeding five years are known as long-term funds. These schemes have higher duration risk when compared to other types of debt funds.

🔹 Dynamic bond funds

Fund managers change the portfolio holdings with different maturity based on their predictions of the interest rate movements. If they forecast the interest rates to be rising, they will hold securities with shorter maturities and vice versa. The fund corpus is invested across securities with short and long-term maturities and is riskier when compared to short-term debt funds.

🔹 Fixed maturity plans

Fixed maturity plans (FMPs) have a lock-in period, and investment is allowed only during the new fund .