Debt Funds
Debt or income funds invest in fixed income generating debt instruments, issued by government, private companies, banks, financial institutions, and other entities such as infrastructure companies/utilities. The main objective of these funds is to generate stable income at a low risk for the investor. As compared to the Gilt funds other debt funds have a higher risk of default by their borrowers.
1. Diversified Debt funds
Diversified Debt Funds
These funds invest in a diversified basket of debt securities. They can invest in debentures issued by Government, companies, banks, public sector undertakings, etc. The objective of these schemes could be to provide safety of capital and regular income. At the same time, some funds may also have an objective of generating higher returns than traditional debt investments. This objective can be achieved by proper management of certain risks, viz. credit risk, interest rate risk or liquidity risk.
Gilt Funds
These funds invest in government securities. Since the funds invest largely in the securities issued by Government of India, the credit risk can be assumed to be non-existent. However, these government securities, also called dated securities, may face interest rate risk, which means as the interest rates rise, the NAV of these funds fall (and vice versa). The NAVs of these funds could be highly volatile, if the maturity is long. These funds are also known as Government Securities Funds or G-Sec Funds.
Short Term Debt Funds
In order to reduce interest rate risk, some funds are mandated to invest in debt securities with short maturity, generally less than 3 years. Such funds earn large part of returns in form of interest accrual and are less sensitive to interest rate movements. These funds may or may not take liquidity and credit risks. One would be advised to read the scheme objectives and investment style to know more about specific schemes. These funds have the potential to earn higher than liquid funds but the NAVs of these funds also exhibit some degree of volatility. At the same time, the volatility is likely to be much lower than diversified debt funds.
High Yield Debt Funds
High quality (those having high credit rating) debt securities offer low interest rates and hence some investors are not happy with such low returns. They are willing to take some risk without getting exposed to the risk of equity. High yield debt funds are ideally suited for such investors. These funds invest in debt securities with lower credit rating. The lower rating ensures the securities offer higher interest rates compensating the investor for the extra risk taken.
Fixed Term Plans
Debt funds are subject to interest rate risk and the NAVs of these funds fluctuate if the interest rates change. Investors willing to hold the investments for a defined term face the risk when they need to take the money out of the scheme. If there was an option where the investor’s risk could be reduced as the withdrawal time approaches, it serves a major purpose for the investor.
Fixed term plans, popularly known as FMPs (Fixed maturity plans), have a defined maturity period; say 3 months, 6 months, 1 year, 3 years, etc. The maturity of the debt securities in which the fund invests, and the maturity of the scheme are almost the same. Hence, when the scheme matures and money has to be returned to the investors, the fund does not have to sell the bonds in the market, but the bonds themselves mature and the fund gets maturity proceeds. Since the fund does not have to sell the bonds in the market, the fund is not exposed to interest rate risk. These are close-ended debt funds. The units of these funds have to be listed on a stock exchange to provide liquidity to the investors. These funds are ideally suitable for investors who know the time when they will need the money and also do not need money before the maturity of the FMP.
Money Market / Liquid Funds
These Mutual Funds invest the investor’s money in most liquid assets, like, Treasury Bills, Certificates of deposit, Commercial papers etc.
These funds can further be categorized as,
1. Diversified Debt funds
2. Short Term Debt funds
3. High Yield Debt funds
4. Fixed Term Plans ( FMPs)
5. Gilt Funds
Diversified Debt Funds
These funds invest in a diversified basket of debt securities. They can invest in debentures issued by Government, companies, banks, public sector undertakings, etc. The objective of these schemes could be to provide safety of capital and regular income. At the same time, some funds may also have an objective of generating higher returns than traditional debt investments. This objective can be achieved by proper management of certain risks, viz. credit risk, interest rate risk or liquidity risk.
Gilt Funds
These funds invest in government securities. Since the funds invest largely in the securities issued by Government of India, the credit risk can be assumed to be non-existent. However, these government securities, also called dated securities, may face interest rate risk, which means as the interest rates rise, the NAV of these funds fall (and vice versa). The NAVs of these funds could be highly volatile, if the maturity is long. These funds are also known as Government Securities Funds or G-Sec Funds.
Short Term Debt Funds
In order to reduce interest rate risk, some funds are mandated to invest in debt securities with short maturity, generally less than 3 years. Such funds earn large part of returns in form of interest accrual and are less sensitive to interest rate movements. These funds may or may not take liquidity and credit risks. One would be advised to read the scheme objectives and investment style to know more about specific schemes. These funds have the potential to earn higher than liquid funds but the NAVs of these funds also exhibit some degree of volatility. At the same time, the volatility is likely to be much lower than diversified debt funds.
High Yield Debt Funds
High quality (those having high credit rating) debt securities offer low interest rates and hence some investors are not happy with such low returns. They are willing to take some risk without getting exposed to the risk of equity. High yield debt funds are ideally suited for such investors. These funds invest in debt securities with lower credit rating. The lower rating ensures the securities offer higher interest rates compensating the investor for the extra risk taken.
Fixed Term Plans
Debt funds are subject to interest rate risk and the NAVs of these funds fluctuate if the interest rates change. Investors willing to hold the investments for a defined term face the risk when they need to take the money out of the scheme. If there was an option where the investor’s risk could be reduced as the withdrawal time approaches, it serves a major purpose for the investor.
Fixed term plans, popularly known as FMPs (Fixed maturity plans), have a defined maturity period; say 3 months, 6 months, 1 year, 3 years, etc. The maturity of the debt securities in which the fund invests, and the maturity of the scheme are almost the same. Hence, when the scheme matures and money has to be returned to the investors, the fund does not have to sell the bonds in the market, but the bonds themselves mature and the fund gets maturity proceeds. Since the fund does not have to sell the bonds in the market, the fund is not exposed to interest rate risk. These are close-ended debt funds. The units of these funds have to be listed on a stock exchange to provide liquidity to the investors. These funds are ideally suitable for investors who know the time when they will need the money and also do not need money before the maturity of the FMP.
Money Market / Liquid Funds
These Mutual Funds invest the investor’s money in most liquid assets, like, Treasury Bills, Certificates of deposit, Commercial papers etc.
These instruments in which Money Market Mutual Fund (MMMF) invests can be encashed at a short notice; capital is safe though returns are low.
Post tax the returns from MMMF may be higher than keeping money in savings account in the bank.
These funds invest in debt instruments of short term nature like Treasury Bills issued by Government, Certificate of Deposits issued by Banks, and Commercial papers issued by companies. These are considered to be most liquid and least risky investment vehicles. Though interest rate risk and credit risk are present, the impact is low as the investment vehicle’s maturities are short and quality of papers is sound.
These are ideal for investors looking to park their short term surplus with an objective of high liquidity with high safety.
These are ideal for investors looking to park their short term surplus with an objective of high liquidity with high safety.
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