Did you know that there is a debt fund to suit every time frame? That’s perhaps the single biggest advantage over equity funds. They also deliver superior returns to traditional debt products like FD, PO Savings etc.
Here are different types of debt funds in which you can invest, based on your goals and investment tenure.
Liquid and ultra-short-term funds
These funds invest in highly liquid money market instruments, such as treasury bills, Commercial Papers (CP), Certificates of Deposit (CD) etc. Liquid funds are suitable if you need the money in less than three months, Ultra short-term funds for goals of six months to a year. An ideal option to supplement your savings bank account which yields lower return.
Short-term debt funds
Suitable for the time frame of one to two years. Invest in a range of CD, CP and other short-term corporate and government bonds. They have a portfolio with an average maturity of upto two years. They hold a small proportion of debt with slightly higher maturity to seek marginally higher returns.
Income accrual and dynamic bond funds
Invest across bonds, corporate debentures and government securities, with a range of maturity profiles. They take aggressive calls based on the interest rate outlook .They are loaded with LT instruments such as gilt when the interest rate is expected to slide and go short in a rising interest rate scenario. The appreciation in the NAV comes from both income accrual and price rally.
These funds may take some credit risks. While they hold a good proportion in high credit-rated instruments, but sometimes, bet on slightly lower rated instruments, hoping to see a re-rating. To take exposure in these funds one must have a long term view (atleast 3 years plus.)
Gilt funds
These funds invest in all types of government debt, including bonds issued by the central bank on behalf of the Centre & state governments. Since gilt funds invest in papers backed by the governments, they carry zero default risk. However, an interest rate risk is still a concern. Infact, LT gilt funds are most sensitive to interest rate changes. Therefore, less suitable for retail investors, who look for debt funds as hedging instruments. HNIs and institutional players may take on these risks.
Fixed maturity plans
FMPs have a fixed tenure. They are typically held till maturity which takes away the interest rate risk. Even if interest rates move up, the fund NAV is not affected. FMPs offer returns that are relatively predictable, though not guaranteed.