Debt funds: Types, features and benefits of debt mutual fund

A debt oriented mutual fund is a mutual fund scheme that invests in fixed income instruments, such as bonds issued by the government and corporate, debt securities, and money market instruments, etc. Debt mutual funds are referred to as fixed-income securities as the investor is aware of the returns to be received from the investment right from the time of the investment. These funds are insulated from market volatility and therefore considered less risky than equity funds.

 

Features and benefits of a debt fund

Here are the key benefits of investing in these funds:

Immune from market volatility: Unlike equity mutual funds, a debt mutual fund is not subject to market conditions. Investments are made in securities with a fixed maturity period and a rate of interest.

Stabilise your portfolio: Since the risk associated with debt instruments is lower than equity instruments, these schemes provide stability to your portfolio.

Great for new investors: New investors usually start with a low-risk appetite. Debt mutual funds serve as a great avenue of investment for such investors. There is steady returns without the fear of losing it all due to markets crashing.

High liquidity: Investment in these funds can be good way to invest surplus cash to build an emergency reserve. If you are in need of urgent liquidity, you can always redeem the investment.

Helps to achieve investment goals: Debt funds have a fixed maturity period and offer low but steady returns. If you have a short term investment objective for building a corpus for an upcoming expense, debt mutual fund is a great option.

 

Types of debt funds

There are different types of debt funds depending on the investment horizon and the risk appetite of the investor.

Liquid & Money Market Funds: As the name suggests, the investment is made in highly liquid money market instruments and debt securities. The tenure of such instruments is usually short and can be held for just one day also. Examples of such instruments include Treasury Bills, Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending & Borrowing Obligations, etc. The primary aim of these funds is to earn money market rates. It is a popular investment avenue for investors who want to park their surplus cash for a short period.

Income funds: These debt mutual funds primarily invest in an array of debt instruments of various maturities & issuers. The investment is usually done in instruments that have medium to long-term maturities. Income funds are suited for investors who have a higher risk appetite and longer investment horizon.

Short-Term funds: These debt funds primarily invest in debt instruments which have shorter maturity or duration. The usual maturity period is up to 3 years. These funds generate good returns when the short-term interest rates are high. The popular instruments in this category include debt and money market instruments and government securities. The investment horizon of these funds is longer compared to liquid funds but shorter than medium-term income funds. These funds are best suited for investors with a low to moderate risk appetite and an investment horizon of 9 to 12 months.

Floating Rate funds (FRF): As the name suggests, these funds primarily invest instruments that offer a floating interest rate. The primary objective of the fund is to minimize the volatility of investment returns. Floating rate securities are linked to a benchmark rate for debt instruments such as MIBOR. The interest rate is reset periodically based on the interest rate movement. Accordingly, the returns vary.

 

Who should invest in debt funds?

Debt funds are a very popular investment option due to the stability and flexibility provided by them. Debt funds are a great option for new and conservative investors. Since the returns are not extremely high but the risk is low, it will not suit the more experienced investors. If you are a short-term investor, consider investing in liquid funds. The returns offered are in the range of 7%-9%. If you are a medium-term investor, choose to invest in dynamic bonds that are immune to interest rate fluctuations and offer good returns.

 

Things to consider while investing in a debt fund

Debt funds are not used as tools to generate huge returns. Most investors park their money in debt funds because they are more stable and less volatile compared to equity funds. The returns offered by debt funds are better than fixed deposits with bank. You should choose to invest in debt funds if you do not have enough debt like investments such as PPF, FDs, savings account etc. There may not be much rationality in picking up a basket of investment options which are all debt-oriented. It is always advisable to maintain a diverse portfolio to stabilize the risk profile.
While debt funds do not get so affected by markets, there are surely other risks like default and liquidity to be considered. That’s why reading the offer documents and gathering as much information you can is essential to any mutual fund investment.

It is also important to take into account the host of charges that come attached to a debt fund:

Mutual Fund Loads: These loads are levied as a one-time charge when an investor starts investing in a mutual fund scheme or exits a mutual fund scheme. The charges are referred to as entry load and exit load. Entry load is levied at the time of investing in a mutual fund scheme. It is deducted from the fund’s Net Asset Value (NAV). SEBI has not prescribed any upper limit of the entry load be levied. As per current SEBI regulations, mutual funds in India are not permitted to charge an entry load.

On the other hand, an exit load is paid by an investor who exits from a mutual fund scheme within a short period of time. One can view the exit load as a form of penalizing the investor to quit prematurely. There is no maximum exit load which can be levied as SEBI has not regulated on this aspect. As a result, different fund houses charge different entry load fees, depending on the holding period.

Transaction Charges : Investors have to pay a nominal charge as transaction fees. This is a fee that is charged only once during an investment. A transaction fee of Rs. 150 for new investors and Rs. 100 for existing investors, can be charged on investments worth Rs. 10,000 and above. For SIP investments, an amount of Rs.100 will be charged as a transaction fee. This fee will be charged only if the SIP commitment is over Rs.10,000 or above. For investments below Rs.10,000, no transaction fee will be levied. Transaction charges are paid to intermediaries or distributors selling the fund.
Indirect costs may be incurred by investors during the investment tenure. Typically, these charges would be related to opening a demat account, maintaining the Demat account, brokerage charges, etc. While buying and selling stocks, a security transaction tax is levied which has to be paid by investors.

In addition to the above, the asset management company and the fund manager also charge their fees. It takes a lot of skill and expertise to manage funds of this scale and nature. The fees include advisory fees, operational costs, investment management fees, registrar and transfer agent fees, legal and audit fees, agent/ sales commissions, ongoing service charges, etc. These expenses add up as the total expense ratio of the mutual fund. The expense ratio is charged annually and is expressed as a percentage and the reporting of the NAV (Net Asset Value).

 

How to evaluate the best debt funds

Choosing the best debt fund does not have a formula. It is difficult to explain what should be the exact process for landing up the best debt fund. Investment in mutual funds should be done after careful consideration and thorough diligence about the scheme. There are a few pointers an investor could keep in mind while evaluating the funds:

Returns from the fund: Observe the past performance and see which funds have performed consistently. This will allow you to carefully analyze the mutual fund and see if it is suited to your needs.

Past performance: Track the performance history of the debt fund you are looking to invest in. It is always good to go with fund houses that are established and well-known. The investment decisions taken by the fund manager are more likely to be in consonance with your investment goals.

Expense Ratio: This can make your investment costlier as the fee is deducted from the returns. Check the expense ratio associated with your fund and try to choose a fund with a lower expense ratio. This would mean that the return would be greater.

Read the offer document carefully: Any mutual fund investment is a significant commitment. The investor must make sure that all the necessary information available with the offering document has been evaluated vis-a-vis the investment objectives.

 

FAQs

 

Do any liquid mutual funds provide guaranteed returns?

There are no guaranteed returns for any mutual fund investments. All mutual fund investments are subject to market risk. Therefore, it is important to read the offer document thoroughly to understand the risks of a mutual fund scheme.

 

Is there a time limit within which the proceeds of redemption of liquid funds are credited to the investor’s account?

Yes, it is usually done within 24 hours. In case of failure to credit the amount within the stipulated time period, the fund house is liable to pay interest as specified by SEBI from time to time for the period of delay. The delayed interest is 15% at present.

 

I came across the term load in the offer document. What does it mean?

Load refers to the charge collected by a mutual fund when the units are sold. There are two types of loads: entry load and exit load. Entry load is levied when the investor buys a unit whereas exit load applied when the units are sold by the investor. At present, SEBI has mandated that no entry load can be charged by any mutual fund scheme. The exit load charged is credited to the scheme.

No scheme is allowed to increase the exit load beyond the level mentioned in the offer document. Any change in the load will be only for future investments and not to investments made earlier. If fresh loads are applicable or increased, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investments.

The investors should take the loads into consideration while making the investment as these affect their returns.

 

What is an application supported by blocked amounts?

ASBA is a facility provided by banks to investors in new fund offers (NFOs) of mutual funds. If you apply for an NFO via ASBA, the application amount gets blocked in your bank account. While the amount stays in your account, it cannot be used until you are allotted the unit of a mutual fund.

 

Do any equity mutual funds provide guaranteed returns?

There are no guaranteed returns for equity mutual fund investments. As the investment amount for an equity-oriented mutual fund is invested in equity, it always remains subject to market volatility. It is important to read the offer document thoroughly to understand the risks of a mutual fund scheme.

 

I have invested in a debt mutual fund scheme. Is it possible that the mutual fund changes the nature of the scheme from debt to equity?

It is possible to change the nature of the scheme. However, SEBI has laid down certain regulations which need to be complied with for affecting such a change:
Any changes in the fundamental attributes of the scheme such as the structure, investment pattern, etc., can be changed only when written communication is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation. The information should also be published in a newspaper published in the language of the region where the head office of the mutual fund is situated.
In case the unitholders do not want to continue with the scheme, they have the option of exiting the present scheme at prevailing NAV without bearing exit load.

 

I have invested in mutual fund schemes. I want to understand how my investment money has been invested. Where I can get this information?

As per SEBI regulations, every mutual fund has the obligation to disclose full portfolios of all of their schemes on a monthly basis on their website. Portfolio disclosure on a half-yearly basis is published in the newspapers. The fund house can also send the disclosure of half-yearly portfolios to their unitholders.

 

What is the Net Asset Value of a mutual fund scheme?

The performance of a particular scheme of a mutual fund is indicated by the Net Asset Value (NAV).
NAV represents the market value of the securities held by the scheme. Since the market value of securities changes every day, NAV of the same scheme varies on a day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For instance, if the market value of securities of a mutual fund scheme is INR 200 lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 20 (i.e.200 lakh/10 lakh). NAV is required to be disclosed by the mutual funds on a daily basis.

 

Is it possible to choose a periodic investment plan to invest in an open-ended mutual fund?

Yes, all open-ended funds allow investors to invest through a Systematic Investment Plan. Regular monthly investments can help you to build a long-term portfolio and add discipline to your investment process.