What are debt mutual funds?

Learn more about debt mutual funds, their types and why should one invest in them.

INVEST
3 mins
15 July 2023

Debt mutual funds are those schemes that invest in fixed-income instruments like government bonds, corporate bonds, money market instruments, commercial papers, and other securities. These offer capital appreciation and regular interest incomes. Financial experts also call these bond funds and income funds.

While debt funds carry fewer risks when compared to equity funds, these funds also generate lower returns than equity mutual funds.

On the Bajaj Finserv platform, we have over 15 categories of debt funds depending on their maturity period. Invest in debt funds to get stable returns and diversify your investment portfolio.

The following sections of this blog will cover important details related to these funds.

Who should invest in a debt fund?

People with a low risk-taking capacity are the ideal investors of debt funds. These schemes suit the following investors:

  • Short-term investors
    People who have an investment horizon of 3 to 12 months can consider investing in debt funds. It is a much better option than keeping funds in a regular savings account. They can consider investing in liquid funds that offer returns of around from 6 to 7%, annually.

  • Medium-term investors
    People who have a medium-term investment horizon of 3 to 5 years can choose debt schemes. For such investors, dynamic bond funds are suitable as they generate higher returns than fixed deposits and short-term bond funds. If an individual wants monthly payouts, they can choose a monthly income plan.

How do debt funds work?

The fund manager of debt funds purchases listed or unlisted debt securities at a particular price. Then, he/she sells them later at a margin, which increases or decreases the fund’s value.

The underlying debt instruments in which the scheme invests also generate periodic interest. There are certain schemes, which earn more interest from fixed-income instruments during the fund's tenure. Interest income gets added to a debt scheme daily.

The Net Asset Value (NAV) of a debt scheme depends on the interest rates of underlying assets. It also depends on the upgradation or gradation of the credit ratings of a fund's holdings. Another factor affecting a debt fund's returns is interest rate movements.

Types of debt funds

There are many different types of debt mutual funds in India. Here are a few unique types:

  1. Liquid funds
    These are highly liquid debt funds. These schemes invest in debt instruments, which have a maturity period of 91 days. One can withdraw a maximum of Rs. 50,000 as an instant redemption facility from certain schemes. Experienced investors consider liquid funds to be the least risky investment option.

  2. Dynamic bond funds
    Debt mutual funds where the fund manager can decide the investment portfolio’s duration are known as dynamic bond funds. Generally, dynamic bond funds have a fluctuating maturity period because their underlying instruments can have short or long maturity periods. These funds carry more risk than short-term debt funds.

  3. Fixed maturity plan (FMP)
    The most important feature of this category of debt schemes is it comes with a lock-in period, which varies depending on the chosen scheme. One can invest in these schemes only during their initial offer periods.

  4. Corporate Bond Fund
    This fund allocates at least 80% of its total assets to the highest-rated corporate bonds. These funds are suitable for those who want to invest in high-quality corporate bonds but have a reduced risk tolerance.

  5. Bank and PSU Fund
    Places at least 80% of its assets in debt instruments issued by banks and PSUs (public sector undertakings).

  6. Gilt Fund
    places government securities of various maturities at least to the extent of 80% of its investible corpus. Credit risk does not exist with these funds. The danger associated with interest rates is substantial.

How debt funds are different from other mutual fund schemes?

Debt mutual funds are not different from other mutual fund schemes when it comes to how they operate. But these mutual funds primarily invest in debt securities and are safer than equity and hybrid funds. However, they usually generate lesser returns compared to both hybrid and equity funds.

You will find a mix of all kinds of debt funds on the Bajaj Finserv platform. You can find details about the fund rating, the scheme allocation, the risk factor associated with the fund, and many such detail that will help you understand these funds better.

Why invest in Debt mutual funds?

Listed below are the reasons why one should invest in Debt mutual funds:

  • Debt funds are considered to be quite liquid as investors can redeem their investments at their convenience
  • These funds are less volatile than equity funds and lend more stability to an investment portfolio. Anyone investing in equities can diversify his/her portfolio using debt funds
  • Debt mutual funds generate better returns compared to traditional investments like fixed deposits

How to pick the right debt fund?

The points below will help one pick the right debt fund:

  • It is essential to understand one’s financial requirements, and preferred investment tenure before choosing a scheme
  • It is a good idea to check the credit rating of the underlying debt securities
  • Investors should check the different types of debt funds and choose the one most aligned with their financial requirements
  • Read about your preferred fund in details on the Bajaj Finserv Mutual Fund platform. Use the comparison feature to choose the right fund for you

What is average maturity and how is it useful?

Average maturity is an indicator, which shows how sensitive a bond is to interest rates. Debt funds with higher average maturities tend to be more volatile in the short term. This is because these funds aim to generate higher returns in the long term.

It is always a good idea to match the average maturity of a debt fund with one’s investment horizon. Suppose that a fund has an average maturity of 4 years. An investor with the same investment horizon does not need to stay invested for 4 years. All it indicates is that one can expect to earn optimal returns for 4 years.

When one decides to invest in debt mutual funds, one must not forget to consider the associated risks. Credit risk occurs when a scheme invests in low-rated debt securities. It can increase the chances of default. Interest rate risk is the risk of bond prices falling when interest rates rise. People should invest in a scheme with risk levels he/she can tolerate. Use the Bajaj Finserv SIP calculator to get an approximate understanding of returns from these funds before making a decision.

Frequently asked questions

Which is better FD or debt mutual fund?

Debt funds can be a fantastic tax-saving investment choice for a number of reasons, even in light of recent developments that seem to indicate they are now on par with fixed deposits.

For example, debt mutual funds are only taxable upon sale of the investments, unlike fixed deposits.
You could have to pay the early withdrawal penalty if you choose ordinary FDs. On the other hand, after a given time, debt funds don't impose any departure loads.

Also, generally debt funds offer better returns but are dependent on the performance of the underlying assets and can fluctuate based on changes in interest rates and other economic factors.

Are debt funds tax free?

Changes made to the Budget 2023 suggest that a Specified Mutual Fund will no longer benefit from indexation when calculating long-term capital gains (LTCG). Debt mutual funds will thereafter be subject to taxation at the appropriate slab rates.

Are debt funds risky?

Debt funds are considered low-risk investments because you are essentially lending money. However, there are some risks to keep in mind. They are:

  • The interest rate risk- Bond value is connected to the interest rate. So when interest rates rise, bond prices fall and vice versa
  • Inflation risk- Bonds provide fixed returns at regular intervals. But if the rate of inflation grows faster than the fixed amount of income, the investor’s money is devaluing.
  • Credit risk- There is always the risk with any lending, that the borrower defaults. In debt funds this is rare, but possible
Disclaimer

Bajaj Finance Limited (“BFL”) is a Non-Banking Financial Company carrying the business of acceptance of deposits, providing lending solutions to Retail & Corporate customers, and is a Corporate agent of various insurance Companies. BFL is also registered with the Association of Mutual Funds in India (“AMFI”) as a distributor of third party Mutual Funds (shortly referred as ‘Mutual Funds’).

BFL does NOT:

(i) provide investment advisory services in any manner or form;

(ii) perform risk profiling of the investor;

(iii) carry customized/personalized suitability assessment;

(iv) carry independent research or analysis, including on any Mutual Fund schemes or other investments; and provide any guarantee of return on investment.


In addition to displaying the Mutual fund products of Asset Management Companies, some general information is sourced from third parties, is also displayed on ‘As-is’ basis, which should NOT be construed as any solicitation or attempt to effect transactions in securities or the rendering any investment advice. Mutual Funds are subject to market risks, including loss of principal amount and Investor should read all Scheme /Offer related documents carefully. The NAV of units issued under the Schemes of mutual funds can go up or down depending on the factors and forces affecting capital markets and may also be affected by changes in the general level of interest rates. The NAV of the units issued under the scheme may be affected, inter-alia by changes in the interest rates, trading volumes, settlement periods, transfer procedures and performance of individual securities. The NAV will inter-alia be exposed to Price / Interest Rate Risk and Credit Risk. Past performance of any scheme of the Mutual fund do not indicate the future performance of the Schemes of the Mutual Fund. BFL shall not be responsible or liable for any loss or shortfall incurred by the investors. There may be other / better alternatives to the investment avenues displayed by BFL. Hence, the final investment decision shall at all times exclusively remain with the investor alone and BFL shall not be liable or responsible for any consequences thereof.

Bajaj Finserv Direct Limited, (“BFDL”), a wholly owned subsidiary of Bajaj Finserv Limited (is a Registered with SEBI as an Investment Advisor with Registration no. INA000016083). BFDL enables resident Indian customers to directly invest in third party mutual funds through its online platform. BFDL entered into a referral arrangement with BFL, whereunder, BFL may, without risk or responsibility on its part, refer the resident Indian customers who are interested in placing their investments in Direct Mutual Funds through BFDL online platform. Investment by a person residing outside the territorial jurisdiction of India is not acceptable nor permitted.

Disclaimer on Risk-O-Meter:
Investors are advised before investing to evaluate a scheme not only on the basis of the Product labeling (including the Riskometer) but also on other quantitative and qualitative factors such as performance, portfolio, fund managers, asset manager, etc. and shall also consult their financial advisers, if they are unsure about the suitability of the scheme before investing

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