How To Build A Debt Funds Portfolio

The debt fund factsheet discloses the duration of the fund portfolio on a monthly basis. Read more about Debt Mutual Fund Portfolio in this blog.
Debt Mutual Fund Portfolio
3 min

Historically, a debt fund portfolio has always been known to be a relatively safer option for investment, particularly in volatile markets. Moreover, spiralling interest rates, uncertain macro environments, and relatively higher returns have influenced investors to move more toward investing in the debt market. However, with RBI rate hikes taking place periodically to tackle inflation, owners of a debt fund portfolio have shown a degree of concern about their returns.

Any mutual fund portfolio usually comprises debt funds that focus on fixed-income securities as investment options. Moreover, investors in mutual funds could adjust their fixed-income portfolios with rising short-term interest rates as the Reserve Bank of India is now more focused on tackling inflation.

How to build a debt mutual fund portfolio?

Investment in short-term maturity options

A debt mutual fund invests in fixed-income securities such as government or corporate bonds and money market-centric instruments. However, since the yield curve’s longer end has greater volatility, investors need to allocate more funds to the curve’s short end. With interest rates rising, and also bond prices dropping simultaneously, the debt mutual fund’s returns are likely to suffer. Investments in short-term maturity options have become more popular under these conditions, with a majority of fund houses accordingly adjusting their debt portfolios.

Investments in PSU, corporate bond, and banking funds

In their efforts to build their debt fund portfolio, it is advisable for investors to allocate their funds into PSU, corporate bond, and banking funds having a portfolio duration ranging between one and three years so that the negative impact of spiralling interest rates on the overall final returns is relatively lower. A part of the corpus is investible in one-year maturity liquid funds or two-year maturity ultra-short-term funds. Yields on such funds are expected to increase soon, while the effect of any rising rates on underlying prices of bonds as also the overall return would be minimal. Moreover, with credit risk funds or PSU debt and yields on banks rising, liquid fund assets can be moved to such categories.

Higher yield

Investments in liquid funds are typically made to avoid any negative impacts on the debt fund portfolio. Liquid funds can offer better returns when compared with savings accounts and fixed deposits but generate relatively lower yields as compared with liquid plus categories. For those willing to take more risk or in extending their investment horizon by at least two years, returns on a debt mutual fund portfolio will definitely be substantially higher than from liquid funds.

Risk-adjusted returns

A debt fund portfolio that comprises short-duration debt securities has the advantage of a lower interest rate risk since the investments tend to roll down, which implies that the maturity decreases over time. Consequently, the funds will remain unimpacted even if the interest rate rises. The basic idea is earning better returns that are also perfectly risk-adjusted.

Other Assorted strategies

The other strategies that investors can adopt for taking advantage of rising interest rates are, investing more in debt schemes or floating rate instruments, concentrating on those instruments that come with floating rates. Funds with floating rates can switch over to new higher-rate securities. However, floating-rate debt funds are high-risk-high-return investment instruments.

What to look for in a debt mutual fund portfolio?

When evaluating a debt mutual fund portfolio, there are several key factors to consider to ensure that the fund aligns with your investment goals and risk tolerance. Here are some essential aspects to look for:

1. Sovereign and corporate mix

  • Sovereign debt: Ensure that the fund has significant exposure to sovereign debt, which is backed by the government guarantee and carries low default risk.
  • Corporate debt: The fund should also have a mix of corporate debt, which carries higher yields but also higher default risk. Ensure that the fund manager has a diversified portfolio to minimise this risk.

2. Credit rating curve

  • Government bonds: Government bonds typically offer the lowest yields due to their low default risk.
  • Corporate bonds: Corporate bonds with higher credit ratings (AAA, AA, etc.) offer higher yields than government bonds but carry higher default risk.
  • Lower-rated bonds: The fund manager should have a strategy to invest in lower-rated bonds (BBB, BB, etc.) to earn higher yields, but this should be done with caution to minimise default risk.

3. Portfolio concentration

  • Avoid concentration: Ensure that the fund does not have excessive exposure to a single company, sector, or promoter group, which can lead to concentration risk.
  • Diversification: The fund should have a diversified portfolio to minimise risk and maximise returns.

4. Portfolio duration

  • Duration risk: Ensure that the fund manager has a strategy to manage duration risk, which is the risk that interest rates may change and impact the fund's returns.
  • Short-term and long-term exposure: The fund should have a mix of short-term and long-term debt instruments to manage duration risk and maximise returns.

5. Fund manager's strategy

  • Investment strategy: Ensure that the fund manager has a clear investment strategy and is not taking excessive risk to earn higher mutual fund returns.
  • Risk management: The fund manager should have a robust risk management framework to minimise default risk and ensure the fund remains stable.

6. Fees and charges

  • Entry and exit loads: Ensure the fund does not have excessive entry and exit loads, which can eat into your returns.
  • Operating expenses: The fund should have reasonable operating expenses to ensure the returns are not eroded by high fees.

7. Portfolio transparency

Portfolio disclosure: Ensure that the fund provides regular portfolio disclosure to investors, which helps in monitoring the mutual fund's performance and risk exposure.

8. Fund performance

  • Historical performance: Evaluate the fund's historical performance to ensure that it has consistently delivered returns in line with its investment objective.
  • Risk-adjusted returns: Ensure that the fund's returns are risk-adjusted, meaning that the returns are adjusted for the level of risk taken by the fund manager.


Risk-averse investors and investors navigating market volatility turn to debt mutual fund portfolios. These portfolios primarily comprise debt funds that invest in fixed-income securities, shielding investors from unfavourable situations like global economic downturns and excessive market volatility. Such funds also offer ease of investment, liquidity, and diversification across several debt instruments. However, investors must also be wary of credit risk and changing interest rates.

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Frequently asked questions

How do you create a debt portfolio?
A debt fund portfolio can be created by strategically investing in several debt instruments while also managing risk for achieving one’s financial goals. It involves the determination of investment goals, risk tolerance, liquidity needs, and the time horizon. Additionally, one needs to diversify also across several debt securities for minimising risk. It is also advisable to consider the reinvestment risk arising from declining interest rates and when cash flows from matured bonds are reinvested at lower interest rates.
What percentage of the portfolio should be debt?
There is no one-size-fits-all answer to this. However, the accepted thumb rule is age-based, where the allocation percentage equals the investor’s age. For instance, if the investor is 30 years old, he must allocate about 30% of his portfolio to debt funds while allocating the remainder to other assorted asset classes or equities.

Is a 30% debt ratio good?
Whether 30% is a good debt ratio depends on the investor’s financial situation, risk tolerance, and goals. It is also critical to assess his objectives carefully and review his portfolio regularly to ensure that his allocation of assets aligns with his needs and prevailing market conditions.

How do you diversify a debt portfolio?
To diversify a debt portfolio one needs to spread out his investments across several debt instruments for reducing the impact of a solitary investment's performance on the overall portfolio. The strategies to diversify a debt portfolio include, diversification of asset class including, government, corporate and municipal bonds; high-quality debt, and geographical, sectoral, credit quality, duration, income issuer, and reinvestment diversification.

What is a healthy debt ratio?
There is no fixed healthy debt ratio since it can vary depending on the context like the industry, the development stage the company is in, and other assorted economic conditions. Generally speaking, however, a healthy debt ratio indicates a manageable debt level in comparison with the company's equity or assets.
Is it good if debt ratio is high?
The goodness of a high debt ratio depends on certain specific factors, such as the debt’s purpose, the borrower's ability to service it, the borrower’s overall financial health, and current economic conditions. Moreover, it is also essential to carefully assess the benefits and risks before concluding whether a steep debt ratio can be advantageous in any given situation.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.