When we hear the word ‘debt’ we usually think of liabilities. However, the term debt fund is different as it has nothing to do with liabilities. It is an investment avenue that can help you make decent profits.
In this article, we’ll explain debt fund meaning and everything else you need to know about the concept.
What is Debt Fund?
Debt fund meaning can be a little tricky to understand. It can be defined as an investment pool that comprises fixed income investments.
It may invest in a variety of options including long-term and short-term bonds, floating rate debt, money market instruments, and securitized products.
Also called fixed income funds and credit funds, debt funds are low-risk and a reliable way to preserve assets. Moreover, the fee ratios on these investment types are also lower than fees attached to equity funds.
Debt Fund Types
Here are the main types of debt funds:
- Overnight Funds: These types of funds invest in short-term securities, i.e.: those with a one day maturity. This debt fund type may be suitable for people looking for high liquidity. However, it doesn’t offer very good returns.
- Liquid Funds: These funds invest in securities set to mature in less than three months (91 days). This is said to be a suitable option for investors looking for an investment vehicle to park cash surpluses for a short period of time. Liquid funds provide reliable returns with little NAV volatility.
- Ultra-short Duration Funds: These funds are suitable for investors looking to invest for three to six months. These offer better returns than liquid funds and are considered very attractive due to low risk. It is common for some ultra-short duration funds to invest in bonds that aren’t very high-rated to push up yields.
- Low Duration Funds: Despite being a little risky, Low Duration Funds are in demand as they offer good returns. They require investing money for up to a year and include bonds that offer high yields.
- Money Market Funds: These funds can be very rewarding as they invest in debt instruments that mature in twelve months. They generate returns in the form of interest income while also offering capital gains.
- Short Duration Funds: These funds are for people looking to invest for a period of up to three years. This debt fund type invests in a combination of long and short-term debt, in addition to credit ratings. While they offer strong returns, it is important to mention that they also show higher NAV fluctuations.
- Long, Medium, and Medium to Long Funds: This investment type requires investment for varied periods – between 3 and 4 years for medium duration funds, between 4 and 7 years for medium-to-long funds, and between 4 and 7 years for long funds. These debt fund types involve investing in both private and public companies including the government sector. These, however, work well when interest markets fall and do not perform well when interest rates rise. Hence, they can be quite risky.
- Fixed Maturity Plans: These invest in highly-rated, low-risk debt and have to be held until maturity. These closed-end funds invest in debt securities according to the scheme’s terms. Despite being a little complicated, they’re very popular as they reduce the risk and allow investors to make money by locking interest rates. However, on the downside, this fund type is not very liquid.
- Corporate Bond Funds: This debt type is different from other options discussed above as these are required to invest at least 80 percent in AA+ or higher corporate bonds. These are said to be suitable for investors looking for safety and a regular flow of income.
- Credit Risk Funds: This option works on the same line as Corporate Bond Funds. They, however, must invest at least 65 percent in AA or below. They tend to offer better results than conservative funds. However, they are riskier than other options, hence may not be suitable for everyone.
- Banking Funds: These invest at least 80 percent of total assets in debt instruments issued by a variety of organizations including public financial institutions and banks. This is said to be suitable for most investors since this option comes with a nice balance of risk and yield.
- Gilt Funds: This debt fund invests in government securities that come with different maturities including long and short funds. They’re said to be the safest debt fund as they invest in g-secs and come with zero default risk.
- Gilt Funds with 10year Constant Duration: This debt fund type requires investing at least 80 percent of available assets in g-secs. However, it might not be suitable for everyone as it requires investors to lock funds for a period of ten years.
- Floater Funds: These require investing at least 65 percent of assets in floating bonds. It is important to understand how floating bonds work to be able to understand this debt fund type. They are safer than most options due to periodic resetting of market rates.
- Dynamic Funds: Last on the list of debt funds is dynamic funds that come with no restrictions on maturity or security type. A little hard to manage, this option can be great for experienced investors.
Benefits of Debt Fund Investment
There are many reasons why so many people invest in debt funds. If you search the web for debt fund benefits, you will come across a variety of answers. Here are some of the main debt fund benefits you need to know:
- Helps Lower the Risk: No investment comes without risk, however debt funds are less risky than some alternatives like equity funds. Debt funds help investors access more markets including wholesale debt markets and money markets. This is important because most investors can’t directly invest in these markets. Plus, they add to diversification and protect overall investments.
- Enjoy Great Liquidity: Debt funds offer great liquidity, i.e.: the ability to convert your investment into cash. It usually takes about 48 hours for a redemption request to be fulfilled. There are no lock-in periods with debt funds; however, some may come with fees in the form of withdrawal charges.
- Offers Great Returns: Debt fund benefits include the ability to earn great returns in the form of capital gains and interest. However, it is important to strategically allocate funds so you can benefit from the top performing debt funds.
- Multiple Investment Options: As highlighted above, you can choose from a variety of debt funds including shorter and longer duration funds. The right strategy can even help people make a stable income.
- Easy to Start: Debt funds are affordable hence suitable for most people. As per SEBI norms, a debt fund’s total expense ratio doesn’t exceed two percent of Assets under Management. Liquid and Overnight funds are the most affordable, while Long-term Funds and Dynamic are slightly more expensive to start.
How to Invest in Debt Funds
It is easy to invest in debt funds as they’re traded like any other ETF or mutual fund. It must be mentioned that buying a debt fund isn’t the same as owning the underlying securities, rather fund shares.
Debt funds allow investors to indirectly take part in the interest paid. The best way to buy debt funds is to work with a stockbroker or investment advisor including online stockbrokers. Moreover, you can even turn to mutual fund companies such as Fidelity and Vanguard.
The amount of money needed to invest in debt funds differs from company to company. It is best that you search for the best debt funds to invest in 2021 and compare debt fund interest rates to pick the best debt fund.
P.S: Check our investing guide for more investing tips.