What are Debt funds?

What are Debt funds?

Debt funds: An Introduction

Debt funds are a type of mutual funds, which can generate good returns from your money by allocating assets in deposits or bonds of various financial securities. These financial securities have a fixed period of maturity and a fixed rate of interest. Debt funds are less risky than other mutual funds because they don’t invest in the equity market for returns.

How do Debt Funds Work?

Debt fund works like giving a loan to a party. You can earn a good amount of interest and capital appreciation if you invest in debt funds. They are often referred to as fixed-income debt funds because an investor knows well in advance about the returns they will get after a fixed maturity date. Based on their credit ratings, these funds usually invest in distinctive debt securities. The credit ratings can decide whether the borrower is worth the credit. It is the work of the fund manager to ensure that only high credit quality instruments are selected for investment.

So if the fund manager invests in high-rated securities, then there will be fewer fluctuations in the rate of returns of the debt funds as compared to low-rated instruments. The maturity of the debt funds totally depends on the fund manager’s vision of the overall scenario, and also on the interest rate regime. If interest rates seem to be declining in the near future, a fund manager may consider investing in long-term securities.

Who Should Invest in Debt Funds?

If you are a conservative investor, then these funds are suitable for you. Other than relying on no equities, you also get the benefit of their flexible lockdown periods. Debt funds are available for both medium term and short term. You can consider 3 months to 1 year for short-term funds and 3 years to 5 years for medium-term funds.

Most people would just settle with keeping their savings in a savings bank account. However, if they invest it in a special category of Debt Funds, namely liquid funds, they could get up to 7 to 9% of returns with the same emergency benefits as of saving bank accounts.

If you are a medium-term investor, you can invest in dynamic bond funds, another category in Debt Funds, rather than opening an FD in a bank. It will get you higher returns than a 5- year bank FD. Another variant in the Debt Fund category is the monthly income plans, wherein there are monthly plans for those investors who want to earn income on a regular basis. To make the right choice, an investor needs to be well-acquainted with the options available in Debt Funds.

what are debt funds

Types of Debt Funds

There are various types of debt funds available in the market, depending on the maturity period of the funds. These are the different types of debt funds:

1. Income Funds:

These funds mostly invest in securities, which offer long maturity and they also invest in debt funds with a distinctive maturity period. These are better than dynamic funds. The period of 5 to 6 years is the average maturity period of these funds.

2. Dynamic Bond Funds:

In these types of funds, portfolio managers usually keep changing the interest rate regime. You will not get a fixed maturity period if you opt for these funds because it has fluctuated maturity period. They generally invest in both longer and shorter maturity period securities.

3. Short-term and ultra short-term funds:

In these types of short-term funds, we generally invest for a very short period of time (1 to 3 years). You don’t need to worry after investing in these funds because their interest rates won’t be affected.

4. Liquid Funds:

If you are looking to invest for 3 months, then these funds are suitable for you because these funds have a maturity period of not more than 91 days. So these are risk-free liquid funds. You won’t see any negative return after investment in these funds. You can try to avoid saving bank account as it also offers the same amount of returns.

5. Gilt Funds:

If you want funds that only invest in government securities then you should invest in gilt debt funds. These securities will obviously have low credit risk because they are protected by government policies. It is best suitable for risk-averse fixed income investors.

6. Fixed Maturity Plan:

These types of fixed maturity plans will invest in government securities and corporate bonds. These all are fixed income securities. Your money will be locked in for a fixed duration of time. This time will be in months or years. You can invest in these plans in only their initial offer period. You will get a better tax-efficient return and the returns with FMPs are usually stable too.

How to invest in Debt Funds?

Nowadays it’s very easy to invest in Debt Funds. You can invest in these funds online. You will need to submit your personal details, your investment requirement, and the respective duration for which you want to invest. You can visit Orowealth.com and invest in direct plans of debt mutual funds. These plans have no commissions and thus will give you higher returns.

Performance of Debt Funds in India

You need to know that some income funds are giving better returns than others. They are offering as much as 57% monthly return. The top leader in this segment is the Indiabulls Income Fund, which recently offered a top return of 57%. Then comes the ICICI Pru Income fund, which offered 51.66% return; followed by Reliance Income Fund, which offered 44%.

List of Top Debt Funds

1. Aditya Birla SL Banking & PSU Debt Fund – (D) Aditya Birla SL Banking & PSU Debt Fund – (D):

This fund is a short-term debt fund, and it is known as Aditya Birla Sun Life Mutual Fund. This fund was launched on 24 April 2008. It will require a minimum investment of Rs. 1000.

2. Birla Sun Life Floating Rate Fund- Long-term plan:

It will come under the category of Ultra Short-term debt funds. You will get a 6.95% return if you invest in this fund, and you will get an 8.49 % return if you invest your money for 3 years. It was launched on March 23, 2009.

3. ICICI Prudential Flexible Income Plan:

You will get consistent returns if you opt for this debt fund. It has a very low risk, so you should try to invest in these types of plans. According to statistics, these funds can provide 9% returns and this continues to increase in upcoming years.

4. Franklin India Ultra Short Term Bond:

It sets the balance between regular income generation and high level of liquidity. This debt fund usually invests in short-term debt securities along with money market to achieve its objectives. This fund can give you returns up to 9.5%. It has only a moderate level of risk.

Benefits of Investing in Debt Funds

• By investing in debt funds, you can be assured that your money will not be affected by equity market fluctuations.

• It will add stability to your investment portfolio because they only invest in debt securities and it will also help you to strengthen your equity portfolio.

• Debt funds mean good tax returns. An investor can earn in the form of dividends or interest payments and capital gains if they have invested in Debt funds.

• You can withdraw from your investment at any time, thus, it gives you the flexibility of using your money when required.

• Debt funds have some tax benefits, as we mention ahead.

Taxation on Debt Funds:

When we invest in debt funds, we earn income from capital gains, which is also taxable. If there is a short-term capital gain (less than 36 months) on the investment, then there will be a marginal tax rate. On the other hand, if there has been a long-term capital gain (36 months and more), then you will be charged with the Indexed tax rate. After indexation, you will be charged with a 20% tax rate. Indexation is one of the primary advantages associated with Debt Funds. What this means is, it takes into consideration the rate of inflation between the year the funds were bought and sold. In this process, the price of debt funds gets inflated as well, thus reflecting a smaller capital gain. This obviously means a smaller amount to the tax.

So, simply put, if your holding period of the debt fund is less than 1 year or between 1 – 3 years, then you will be charged as per the income tax slab you fall in. However, if you have a holding period of debt funds for more than 3 years, then you will be charged with 20% tax after indexation benefits.

Conclusion

After reading this article on Debt funds, you must have realized that investing in the right debt fund can get you tax benefits and higher returns than saving bank accounts and Bank FDs. However, the market is a volatile place, and no returns are guaranteed, but only most probable. You can invest in debt funds through various different options. The fund manager will play a key role in investing securities to maintain a higher percentage of returns.

Nitin Agarwal
Nitin Agarwal
nitin@orowealth.com

Nitin is the Co-founder and CEO at Orowealth and has worked at Deutsche Bank for 6 years in Equity Structuring across their London and Singapore offices. He is a MBA from IIM Bangalore and has a degree in Electrical Engineering from IIT Bombay.

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