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Types of debt mutual funds

You are unique, and so are your financial needs. Why then, must you follow a formula that has worked for someone else? Debt mutual funds can bring in the stability that your mutual fund portfolio may need. But out of the different types of debt fund, how do you choose? Well, the choice is made keeping in mind your risk appetite, investment horizon and the financial goal that you are investing for. Let us look at the types of debt funds in India.

Overnight Funds
These debt funds invest in securities that mature overnight, i.e. a maturity of 1 day. The aim here is to provide you with a safe place to park your capital for a short period of time at relatively lower risk than any other fund. The returns from overnight funds are relatively lesser than other categories too.

Liquid Funds
Liquid funds invest in securities that have a maturity of up to 91 days. They have a relatively higher risk than overnight funds but are still a safe option to park your funds. They may provide you with better opportunities at garnering returns, when compared to overnight funds.

Ultra-Short Duration Funds
Ideal for investors who want to invest their money for at least 3 months, these funds can provide higher returns than the liquid funds and are low on risk as well. Depending on the investment objective of the scheme, the credit risk may vary.

Low Duration Funds
If you want to invest your money for a period of 6 months to 1 year, then low duration funds can be a safe choice. They carry relatively lower risks and have the ability to provide better returns than the ultra-short duration funds.

Money Market Funds
Money market funds invest in securities like Commercial Papers, Certificates of Deposit, Treasury Bills etc. that have a maturity of up to/less than 1 year. Again, the credit risk may vary depending on the credit quality of the securities involved. Investors with relatively lower -risk appetites may find this fund suitable.

Short Duration Funds
Short Duration funds may invest in a mix of short and long-term debt securities and may also invest across various credit ratings. The instruments are chosen such that the portfolio duration is between 1-3 years. This duration is also called Macaulay Duration. They can generate more returns than liquid and ultra short term debt fund, but are prone to relatively higher risks.

Medium/Medium to Long/Long Duration Funds
The Macaulay duration of a medium duration fund typically is 3-4 years, medium to long duration is 4-7 years, and long duration is more than 7 years. These funds are quite sensitive to interest rate changes. Hence, they tend to do well when interest rates are falling and vice versa.

Fixed Maturity Plans (FMPs)
These are closed-ended funds that invest in securities that match the term of the scheme. They hold their investments till maturity. Hence, the interest rate risk is low, and the returns are relatively more stable.

Corporate Bond Funds
Corporate Bond funds invest in bonds that are highly rated, i.e. 80% of the investment are in AA+ and above rated corporate bonds. Hence, the credit risk associated with them is relatively low.

Credit Risk Funds
These are relatively high-risk debt funds because they invest at least 65% of their assets in securities with credit rating AA or below. Because of the credit risk they take, they have an opportunity to generate higher returns than their more conservative counterparts.

Banking and PSU Funds
As the name suggests, these funds invest at least 80% of their assets in debt instruments issued by banks, Public Sector Undertakings, Public Financial Institutions and and Municipal Bonds. These funds seek to maintain a balance between liquidity, the stability of returns and the value of returns.

Gilt Funds
Gilt funds invest a major part of their assets (at least 80%) in Government Securities. The securities can be long or short duration depending on the investment objective, and they typically have low credit risk owing to the investment in the G-Secs. They are ideal for investors who have an investment horizon of 3 years or more and can be carrying high-interest rate risk in the short term. Gilt Funds with 10-year constant duration maintain a constant duration of the portfolio at 10 years.

Dynamic Bond Funds
Dynamic Bond funds can invest across maturities or securities depending on the investment objective of the scheme. The fund manager is free to invest in any security based on the market outlook. They are better for investors with a long-term investment horizon and can see interest rate risk in the short-term. Owing to the flexibility, the returns from this scheme can be relatively higher.

Floating Rate Fund
Floating rate funds invest at least 65% of their assets in floating-rate instruments. Their aim is to provide investors with flexible interest income, especially when the interest rates are on the rise. They are generally high on stability.

Out of all the debt fund types, have you decided the debt fund that suits your requirements? Click here to know how to invest in debt funds and begin your journey today!

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