InvestorQ : What are the different types of debt funds or income funds that are available in the market for investing for a small investor?
Neelam Naik made post

What are the different types of debt funds or income funds that are available in the market for investing for a small investor?

Priyanka N answered.
3 years ago

We are normally considering debt funds as one single category but you must know that debt funds have a number of sub categories too. The following are some of the key types of debt funds that are available under the category of debt funds for mutual fund investors in India.

a) Long Term Debt Funds: These funds essentially invest in government securities and corporate debt paper with longer maturities of 5 years or 10 years. Such funds are normally more impacted by interested changes. So if rates move up, these funds see greater capital depreciation and if rates move down they see greater capital appreciation.

b) Short Term Debt Funds: These funds are the shorter end variant of the Long Term debt funds and they invest in short term instruments like shorter tenure G-Secs, short term corporate papers, money market instruments like treasury bills, Commercial Paper (CP), certificates of deposit (CD) etc. The NAV of such funds is less vulnerable to shifts in the interest rates in the market.

c) Credit Opportunities Fund: This is a fund that takes a slightly higher degree of credit risk on its books. Investing in high quality AAA rated bonds is the safest way to buy bonds but then yields on these high rates bonds is also low. Therefore, Credit Opportunity Fund adds bonds that are AA rated as they give higher yield. It needs to be remembered that selection of the bond is very critical here as lower the rating, higher the risk of default. Hence it is essential to restrict to companies with management quality and pedigree.

d) Floating Rate Debt Fund: – Short Term: There are two types of bonds. The most common are the fixed rate bonds that pay a fixed rate of interest. There are also floating rate bonds that pay interest that is variable and moves with a benchmark like the MCLR or the Bank rate. Such funds invest in such floating rate instruments with a shorter maturity.

e) Floating Rate Debt Fund: – Long Term: This is an extension of the short term Floating rate fund with a longer maturity. These funds also invest in floating rate instruments but with a longer period of maturity. Such funds work best when rates are moving up and tend to lose money when rates are moving down. Fixed rate funds are more lucrative when rates are headed downwards.

f) Ultra Short Term Funds: – In Indian mutual fund parlance, these funds are also known as liquid-Plus Funds. Typically, liquid funds will invest in short term paper with maturity of less than 1 year. But then yield on such papers is also very low. An Ultra Short Term Fund adds a little bit of long term paper to enhance the yield on the fund compared to a pure liquid fund. Most Ultra Short Term Funds have an exit load while liquid funds do not have any exit load. These are quite popular among institutional investors.

g) Short term Gilt Funds: – As the name suggests, these funds invest purely in gilt instruments only. Gilt refers to government bonds, essentially of the central government of India. However, some gilt funds may also invest in select state government bonds to enhance yields. Short term gilt funds invest in government bonds with a residual maturity of less than 1 year.

h) Long Term Gilt Funds: – This is another version of the short term gilt fund. Like in the previous case, these funds also invest purely in government bonds only but the only difference being that maturity is much longer in this case. Such funds tend to be more vulnerable to changes in the interest rates.

i) MIP Aggressive Funds: – MIPs or monthly income plans are the reverse of a balanced fund. A balanced fund typically has an equity exposure of 65% or more. That gives them the added benefit of favourable tax treatment as an equity fund. An MIP has a much higher proportion of debt and a lower proportion of equities. In an Aggressive MIP, the proportion of equities may be as high as 25-30%. While the debt component will give stability, the equity component gives the alpha and the capital growth.

j) MIP Conservative Funds: – Like any MIP, this is also a debt/equity mix with a predominance of debt compared to equity. Unlike an Aggressive MIP which has an equity component of up to 25-30%, a conservative MIP restricts its equity exposure to just about 5-10%. Here equity is not exactly used for long term wealth creation but purely from the point of view of getting slightly higher returns.

These are the broad categories although many funds do sub categorize these into much smaller categories as a unique selling proposition for clients.