What are the categories of Debt Funds?

Debt funds fall into different categories and they have always puzzled the investors. Here is a brief description of the major categories of debt funds.

Types of debt funds 300x300 What are the categories of Debt Funds?

1.Gilt funds

Gilt funds are mutual funds that allow you to invest only in government securities and treasury bills, which do not have a credit risk (i.e. the risk that the issuer of the security defaults). It is the best option for new investors who want to invest in the market with low risk.

2.Diversified debt funds 

These funds invest in a mix of government and non-government debt securities such as corporate bonds, debentures, and commercial paper. These schemes are also known as Income Funds.

3.Junk bond schemes or High yield bond schemes

Investment is made in companies that are of poor credit quality. Such schemes operate on the premise that the attractive returns offered by the investee companies make up for the losses arising out of a few companies defaulting.

4.Fixed maturity plans

These are a kind of debt fund where the investment portfolio is closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified investments. Further, being close-ended schemes, they do not accept money post-NFO(New Fund Offer).

Such a portfolio construction gives more clarity to investors on the likely returns if they stay invested in the scheme until its maturity (though there can be no guarantee or assurance of such returns). This helps them compare the returns with alternative investments like bank deposits.

5.Floating rate funds

These mutual funds invest largely in floating rate debt securities i.e. debt securities where the interest rate payable by the issuer changes in line with the market.

For example, a debt security where interest payable is described as‘5-year Government Security yield plus 1%’, will pay interest rate of 7%, when the 5-year Government Security yield is 6%.

The NAVs of such schemes fluctuate lesser than other debt funds that invest more in debt securities offering a fixed rate of interest.

6.Liquid schemes or Money Market Schemes

Liquid Schemes are a variant of debt schemes that invest only in short-term debt securities. They can invest in debt securities of upto 91 days maturity. However, securities in the portfolio having maturity more than 60-days need to be valued at market prices [“Marked to Market” (MTM)].

Since MTM contributes to the volatility of NAV, fund managers of liquid schemes prefer to keep most of their portfolio in debt securities of less than 60-day maturity. As will be seen later in this Work Book, this helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with the safety of capital.

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