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What is a Debt Mutual Fund?

What is a Debt Mutual Fund?

Published on 14 December 2021 .Views 5 .Comments 0
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1. What Is A Debt Mutual Fund?

Debt mutual funds are mutual funds that invest in fixed income instruments. "Debt" the word itself means loan. Debt mutual fund gives loans to government, businesses and financial institutions and hence Debt funds invest into fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt instruments of different time horizons. Debt mutual funds are like baskets that hold dozens or hundreds of individual securities (in this case, corporate bonds, govt. securities etc.).

A Debt fund manager researches fixed income markets for the best bonds based upon the overall objective of the fund. The manager then purchases and sells bonds based upon economic and market activity. And then, this interest income that the fund receives from the bonds they invest in, is passed on to us.

Debt mutual funds are suitable for your short-term goals (<3 years) or for investors who are conservative, not active in the market and require regular income. The debt mutual funds can provide regular income and are less risky and you should have lower return expectations from them.

2. How Debt Funds Are taxed?

Debt Funds are taxed based on your holding/investment period.
If you redeem your investments before 3 years, then gains are treated as Short Term capital gains and if you redeem them after 3 years they are treated as Long Term Capital Gains.
Short term gain will be taxed as per slab and long term capital gain will be taxed @ 20% on gain ( with indexation)

3. What Are Various Types Of Debt Funds?

a. Gilt Fund:

Gilt funds are a type of mutual funds, which invest exclusively in government securities. When Government of India requires any funds it borrows from RBI, in return of loan RBI issues government securities, in which fund manager invests funds money.

Gilt fund is one of the most liquid fund liquid debt funds as secondary market of Govt. securities is active and has good volumes. Most of the debt funds do not charge any Exit load on such funds. As these kinds of funds only invest in Government securities credit risk is very low and so is the return as compared to other funds.

Examples- SBI Magnum Gilt Fund, is the biggest Debt Fund by Asset under management in this category.

b. Credit Risk Fund:

Earlier these funds were known as credit risk opportunities fund. These debt fund invest their 65% or more money in AA- rated or less rated papers. The reason why it is called credit risk fund is that it takes lot of risk by investing in less rated paper, but higher the risk higher is the return.

These funds follow accrual strategy to provide a better return. Accrual strategy is nothing but buying a company with lower credit ratings at the moment, hoping that the ratings go up. The credit risk fund earns return in two ways in form of interest on the securities and capital gain if security rating improves.

These funds typically have the potential to give 2-3% higher returns compared to risk-free papers. Credit Risk Funds are one of the riskiest debt funds. Due to their high credit risk, they are highly dependent on Fund Manager skills. They are for high risk investors who want to invest money for short term in Debt market (less than 3 years). These funds carry low to medium interest rate risk

Investors who seek a steady income and wants to keep the risk factor minimal should stay away from this category of funds.
Risks- low to medium interest rate risk but High Credit risk.

c. Liquid Fund:

Liquid Funds are open-ended debt mutual funds that primarily invest in short-term money market instruments with maturity up to 90 days. Liquid mutual funds invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills, etc.

  1. There is no lock-in period of these funds, withdrawal from these funds are processed within 24 hrs.
  2. They do not charge any exit load and hence are very liquid
  3. There is low interest rate risk. As interest rates go down, bond prices go up,given that liquid funds mainly invest in fixed income securities which have a short maturity period, they have one of the lowest interest rate risks as compared to other debt funds.
  4. Less risky than other debt funds
    Immediate liquidity - SEBI has recently mandated that AMC’s should allow instant redemptions of up to Rs. 50,000 from Liquid Funds. Asset management companies (AMCs) will offer instant redemption of Rs 50,000 or 90% of the folio, whichever is lower, in liquid funds.
  5. Features of Liquid fund:-

We can say that the Liquid funds are less risky, highly liquid but provides less returns.

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