What Exactly Is a Debt Fund? In-Depth Understanding of Debt Funds

Of the numerous investment options that are available in India, mutual fund schemes are one of the preferred options. In these schemes, the asset management company (AMC) pools money from more than one investor and places them in a fund. Once enough money is accumulated into the fund, it is used to invest in different financial securities. By purchasing a unit in a mutual fund scheme, you get to own a small stake in all the investments that are regarded as a part of the fund. Thanks to the numerous benefits that are associated with mutual funds, they are considered a prudent investment choice.

However, signing up for a mutual fund scheme is not enough. Selecting the right plan is also very imperative. These plans are not a monolith. There are different types of mutual funds that are available as investment options in India. Each of these different variants of mutual fund schemes is known for allocating funds to different financial securities. There are two mutual fund schemes that are prominent examples of the different variants of mutual funds. Those examples are equity funds and debt funds. In accordance with its name, equity funds are known for investing in equities. Debt funds on the other hand are different.

What are debt funds?

These mutual funds are known for investing in fixed-interest-generating financial securities such as government securities, commercial paper, treasury bills, corporate bonds, and several other money market instruments. The central reason why people prefer to invest in debt funds is to enjoy capital appreciation and steady income. Those issuing debt instruments are known for already deciding things like the interest rate you will receive and the maturity period of the fund. Therefore, these schemes are also referred to as ‘fixed-income’ securities.

How do debt funds work?

These funds are known for coming with one objective. The said objective is to generate returns by investing the investor’s money in avenues like bonds and fixed-income securities. Debt funds are known for buying bonds and later earning interest income on the money. The yields that debt mutual fund investors receive are based on this.

Debt funds are known for allocating funds to a wide range of securities. The investments are made towards securities after analysing their credit ratings. The fund manager who takes care of a debt fund makes sure that he invests in credit instruments that have a high credit rating. A high credit rating means that the security will more likely pay interest on the debt security at regular intervals.

Investments made towards higher-rated securities are less volatile in comparison to low-rated securities. In addition, the maturity period is also dependent on things like the investment strategy followed by the fund manager and the general interest rate regime followed by the economy. If the interest rate regime is on falls, it encourages the fund manager to direct investments towards long-term securities. On the contrary, if the interest rate regime is on a rise, the fund manager invests in short-term securities.

What are the benefits associated with debt funds?

Here are some of the reasons why you should consider investing in debt mutual funds:

  • The performance of these funds is not dependent on market fluctuations:

As stated before, in these mutual funds, the portfolio manager allocates funds to fixed-income securities like corporate bonds, treasury bills, commercial papers, and government bonds. These securities are known for being instruments that are known to yield money to investors at regular intervals. Therefore, irrespective of the market condition, it will not impact the income generated by the scheme. If you were to sign up for a debt mutual fund and the market is in a bear phase, don’t worry, the market’s low performance will not have an impact on your revenue.

  • These funds come with lower risks:

In this type of mutual fund, investments are directed to securities like corporate bonds, treasury bills, commercial papers, government securities, and several other types of money market instruments. Fund allocation to these securities ensures that you can enjoy debt fund returns at regular intervals.

Who are debt funds ideal for?

Debt funds attempt to optimise returns by diversifying investments across all asset classes. This enables debt funds to earn decent returns. It is also important to note that while returns in debt funds are known for often falling in a predictable range, they are not guaranteed, making them a safer option for conservative investors.

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