Investing is not always about selecting the investment that offers the highest returns. It is also about choosing one that aligns with your financial goals and level of risk tolerance.
Debt funds provide opportunities for investors looking to invest in fixed income securities. However, with several types of debt funds available, new investors may struggle to understand the differences. Let’s examine five common types of debt funds and understand how they differ.
What are debt funds?
Debt funds are mutual funds that invest in fixed income securities such as government securities, bonds and other debt instruments.
Investing in a debt fund allows the fund manager to invest the pooled capital in such securities. The fund earns returns through the interest generated by the underlying securities and changes in their market values.
However, debt funds do not provide guaranteed returns. The value of these funds may change due to factors like changes in interest rates and the credit quality of debt securities held in the portfolio. Therefore, it is important to understand the debt fund you are investing in.
5 types of debt funds
Here are five types of debt funds that every beginner should know:
1. Liquid funds
Liquid funds invest in short-term debt and money market securities with a maturity of up to 91 days. As the period of these securities is relatively short, these funds offer limited exposure to changes in interest rates.
These are commonly used for fulfilling short-term financial goals. For example, if you have some capital that you may need after a few weeks or months, then investing in liquid funds may be a good option.
2. Overnight funds
Overnight funds invest in securities with a maturity of one day. Due to their extremely short duration, they are among one of the shortest duration debt funds.
As these securities mature quickly, these funds have low sensitivity to changes in interest rates. These funds are useful for investors looking to invest their capital for a very short period. However, returns from overnight funds can be influenced by short-term market conditions.
3. Short duration funds
Short duration funds invest in debt and money market securities with a Macaulay duration of one to three years. As a result, they have a longer investment time period than liquid and overnight funds.
Consequently, these funds are more sensitive to changes in interest rates. Investors looking to invest for a medium term can consider investing in short duration funds. However, it is important to evaluate the credit quality of securities held in the fund.
4. Corporate bond funds
Corporate bond funds invest mainly in bonds issued by companies. According to SEBI norms, at least 80% of their assets are invested in high rated corporate bonds.
When companies need to raise capital, they issue bonds to investors. Investors can put money into a corporate bond fund through a share market app, and the fund then invests in these bonds on their behalf. These funds provide an opportunity to invest in corporate debt, but it is important for investors to review the portfolio, as high quality bonds are subject to interest rate and market-related risks.
5. Gilt funds
Gilt funds mainly invest in government securities. According to SEBI regulations, these funds are required to invest at least 80% of their assets in government securities.
As these securities are issued by the government, gilt Funds have relatively low credit risk. However, they can be sensitive to changes in interest rates. This is particularly relevant when a fund holds longer-maturity government securities, as their prices fluctuate more when interest rates change.
Conclusion
Debt funds provide investors with various ways to invest in the fixed income market, with each category having its own maturity and risk level. Liquid and overnight funds invest in short-term securities, while short duration, corporate bonds and gilt funds cater to different investment needs.
Therefore, before investing in debt funds, it is important to consider your investment horizon, risk tolerance, portfolio quality and interest rate sensitivity rather than relying solely on historical returns. By understanding these factors, you can choose a debt fund category that aligns well with your financial goals.
