India Today


Investing in debt funds could provide a regular income stream and stability to portfolio returns

- —Narayan Krishnamur­thy

When it comes to mutual fund (MF) investing, most people assume equity is the only way to go. But there is a range of debt funds with varying degree of risks and time-frames to invest. Debt funds work on the principal of traditiona­l debt instrument­s such as bank fixed deposits, small savings schemes and other bonds that provide a fixed interest payout. Debt funds invest in debt or fixed income securities of various corporate institutio­ns and the government and are also known as income funds. But this doesn’t mean that debt funds are immune to ups and downs or guarantee fixed returns like, say, FDs.

Many of the instrument­s debt funds invest in, such as corporate bonds, PSU bonds, debentures, commercial papers, treasury bills etc. are not always open to individual investors. Debt funds play the role of a facilitato­r to invest in a diverse universe of debt instrument­s that require intricate investing knowledge. Moreover, unlike traditiona­l debt instrument­s, debt funds invest in tradeable debt instrument­s in the market segment where such trades occur, making them earn superior returns compared to a standard FD.


There are a few compelling reasons to invest in debt funds—diversific­ation among the universe of debt instrument­s, superior returns, liquidity and tax efficiency being a few. These also provide the convenienc­e of mutual fund investing by way of investing small regular sums to suit an investor’s financial needs and suitable time-frame. At the same time, debt funds also carry risks like any other financial instrument (see Debt Fund Risks).

For the sake of investors, market regulator SEBI introduced a comprehens­ive categorisa­tion exercise under which debt funds are defined, including the kind of securities they can invest

in (see Debt Fund Universe). With the standardis­ation, comparing and choosing a fund has become easy for investors. There are funds in which one could invest for as less a day to a week to those that cover over five years.


Debt funds primarily follow two different strategies to earn returns—accrual-based and duration-based—and both involve different roles and risks. For instance, in case of accrual strategy, the focus is to generate returns from interest income by managing credit risk, while minimising interest rate risk.

In this approach, securities held by the fund are held till maturity, which is followed by shorter maturity funds. Duration-based strategy focuses on capital appreciati­on by way of rise in price of the underlying bond due to fall in interest rate. The focus is not interest income but the way the bond price will move owing to interest rate changes. In such funds, investment­s are generally in long-term debt instrument­s where the interest rate risk is managed. Such a strategy is mostly followed by longer duration funds as well as gilt funds.

When investing, it is important to define one’s investment time-frame (see A Suitable Fund). For instance, if your need is to park money for a few weeks or months, an overnight fund or liquid fund is suitable compared to, say, a gilt fund. Finally, fund selection should be based on its pedigree, past track record, the corpus it manages, and the fund manager’s experience. ■

 ?? Illustrati­on by SIDDHANT JUMDE ??
Illustrati­on by SIDDHANT JUMDE

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