Types of Debt Mutual Funds: What You Need to Know

A mutual fund is an investment tool that brings the money of many investors together. Purchases of securities are then made from this pool of collective funds. This also includes liquid securities, government and corporate bonds and public companies stocks. Mutual Funds are categorised into various types. One such category of mutual funds is Debt Mutual Funds. Debt Funds - This category of mutual funds invests in fixed-income instruments.

**Debt Mutual Funds: What are they? **

Debt funds employ the funds provided to invest in different types of debt securities, like government or corporate bonds. They buy these instruments at a discounted price and then sell them on margin at a later date.

The difference between the instrument's purchase and sale prices influences the fund's net asset value (NAV). Debt mutual funds have two goals over many years. They are to keep capital safe and provide steady income.

Types of Debt Mutual funds

Liquid Funds

Liquid funds invest in money market instruments. These investments can last at most 91 days. These funds are very liquid. Investors can easily turn their investments into cash.

Money Market Funds

Money market funds usually have a one-year maturity. But, they still invest in money market securities. These funds are for low-risk, short-term investors. They strive to offer great liquidity and protect capital.

Corporate Bond Funds

Corporate bonds rated AA+ or above can make up as much as 80% of the portfolio in corporate bond funds. Generally speaking, conservative investors who seek stable income and principal preservation should consider these funds.

Credit Risk Funds

Invests a minimum of 65% in corporate bonds, but only in bonds with ratings of AA or below.

Banking and PSU Funds

The funds invest at least 80% of their assets in debt instruments.

These debt instruments are issued by public financial institutions, PSUs, and banks. This product aims to balance yield, safety, and liquidity. It carries a moderate risk.

Gilt Funds

Government securities with different maturities are invested in by gilt funds. Depending on the age of their portfolio, these can be either long- or short-duration funds. Since they make investments in secure g-secs, gilt funds have no default risk.

Gilt Fund with 10 year constant Duration

A minimum of 80% in G-secs is required so that the portfolio's Macaulay duration equals ten years.

Floater Funds

Floater funds allocate a minimum of 65% of their total assets to bonds with floating rates. Because the coupons on the floating-rate debt that these funds own are periodically reset under market rates, they have less mark-to-market risk.

Overnight Funds

Overnight funds invest in securities, usually money market instruments, with a one-day maturity. The funds do not focus on big returns. It is for those who want to park money for a very short time. This is primarily corporate treasuries.

**Dynamic Bond **

The tenor of the securities in a dynamic bond fund is adjusted based on projected interest rate changes. If it is anticipated that interest rates would decline, the tenor is extended, and vice versa.

Fixed Maturity Plans

These funds invest in debt instruments. The maturities of these debts match the program's limits. FMPs typically invest in highly rated, low-risk debt.

The FMP structure's main benefit is that it lets investors lock in interest rates. It also removes interest rate risk.

Based On Duration

1. Ultra-short duration

Investors that have a minimum three-month investing horizon may consider these.

2. Low duration funds

These funds offer good returns at a modest risk. For individuals wishing to invest for a period of 6 months to a year, they are helpful.

3. Short-duration funds

Investments in short-duration funds cross credit ratings. They mix short- and long-term debt wisely. It is advised to invest in these funds for a period of 1 to 3 years.

4. Medium to Long, and Long Duration funds

A medium-duration fund's portfolio duration should normally fall between 3 and 4 years, a medium-to-long fund between 4 and 7 years, and a long fund's longer than 7 years.

Taxation of Debt Mutual Funds

The new current income tax rules, which are the most up-to-date, state that the LTCG and STCG from mutual funds will be taxed according to your income tax slab— with no indexation benefit in debt funds post-April 1, 2023 investments.

Here's a closer look at this:

Short-Term Capital Gain

Investors generate capital gains at the time of redemption which occur when you invest in debt mutual funds for up to 3 years— these are Short-Term Capital Gains (STCGs). Such gains form part of your income and are taxed at income slab rates.

Long-Term Capital Gain

LTCG, or long-term capital gain, refers to any profit you have earned on your investments beyond three years. These earnings are subject to a uniform tax of 20% with indexation benefits.

In summary

Investors have a wide range of choices when searching for fixed-income investments. Investors can pick the best debt mutual funds that fit their investment horizon. They must fit their risk tolerance and financial goals.

They can do this by being aware of the many kinds of debt funds. Every investor has access to a debt mutual fund that suits their needs.