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What Are Debt Funds? Research Team | Posted On Thursday, January 31,2019, 02:45 PM

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What Are Debt Funds?



Debt funds are a type of mutual funds that invest in fixed income instruments like corporate bonds, government bonds, treasury bills, money market instruments and so on to offer capital appreciation. Debt funds are also called fixed income funds or bond funds.

Investing in debt funds is ideal for those investors who want regular income. Debt funds are usually less volatile and less risky. Investing in debt funds is a better option than fixed deposits as this offers tax benefits for those in higher tax brackets.

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See Also: Taxation of Debt Funds

What Are Debt Funds?

Types of debt funds

Gilt Funds:

Gilt funds invest in Government bonds and securities with fluctuating maturities. On an average, maturity of government bonds in the portfolio of long term gilt funds ranges between 15 to 30 years. The returns on gilt funds are affected due to fluctuations in interest rate. The NAVs of gilt funds are extremely volatile. The main goal of gilt funds is capital appreciation. Investors willing to take moderate risk can invest in gilt funds.

Income Funds:

Income funds invest in a wide range of fixed income securities like bonds, debentures and government securities, with different maturities. The investment strategy is a mixture of both hold to maturity (accrual income) and duration calls. These funds are sensitive to fluctuations in interest rate. Investors who are ready to take moderate risk can invest in these funds.

Short Term Debt Funds:

Short term debt funds invest in Commercial Papers (CP), Certificate of Deposits (CD) and short maturity bonds. The average maturity of securities in the portfolio of short term bond funds ranges between 2 to 3 years. The fund managers use a predominantly accrual (hold to maturity) strategy for these funds. Short term debt funds are apt for investors with lower risk tolerance, looking for safe investment and stable income.

SEE ALSO: What Is Wealth Management?

Credit Opportunity Funds:

Credit opportunity funds are similar to short term debt funds. Fund managers lock in a certain percentage points of additional yield by investing in slightly lower rated corporate bonds. The average maturity of bonds in the portfolio of credit opportunities funds ranges between 2 – 3 years. Credit Opportunities funds are suitable for those investors who are ready to take high risks, looking for higher income than short term debt funds.

Fixed Maturity Plans:

Fixed Maturity Plans (FMPs) are a type of close ended scheme. Investors can invest in this scheme only during the offer period. The duration of the scheme is fixed. FMPs invest in fixed income securities of maturities matching the duration of the scheme. This is done to reduce reinvestment risk. The returns on FMPs are very stable as the bonds in the FMP portfolio are held till maturity. FMPs are apt for those investors who are ready to take low risks. FMPs offer stable returns and tax benefits over an investment period of 3 years or more.

Liquid Funds:

Liquid funds are a type of mutual funds those invest mainly in money market instruments like treasury bills, certificate of deposits, commercial paper and term deposits. Main objective of liquid funds is to provide investors an opportunity to earn better returns, while not compromising on the liquidity of investments.

They invest in money market securities that have a residual maturity of 91 days or less. Liquid funds offer higher returns than savings bank account. No tax is deducted at source for liquid fund returns. There is no exit load. Withdrawals from liquid funds are processed over a very short period. Liquid funds are best suitable for those investors who have substantial amount of cash at their disposal.

SEE ALSO: Bharat Bill Payment System (BBPS) of India

Monthly Income Plans:

Monthly income plans are debt hybrid mutual funds. These funds invest 75 – 80% of their portfolio in fixed income securities and the rest in equities. Monthly income plans generate higher returns than pure debt funds. However, the risk is also slightly higher in monthly income plans when compared to most debt fund categories due to its investment in equity.

Advantages of debt funds:

Following are the advantages of debt funds:

  • Offer liquidity unlike fixed deposits
  • Better investment option for tax benefits
  • Debts funds offer better returns
  • Debts funds are safer when compared to equity mutual funds
  • Debt funds are flexible in nature

Debt funds vs Equity Funds


Debt funds

Equity funds


Steady and constant, lower than equity funds.

Much higher returns than debt funds.




Invest in

Treasury bills, government and corporate bonds and securities


Offer better returns when

Markets are volatile

Markets are booming

How to invest in debt funds?

You can invest in debt funds both online and offline. For both, you must first complete the KYC process. Post completion of KYC, you must log on to the official website of the mutual fund house and fill the online application form. You need to have bank details and KYC ready.

For offline investment, you need to visit the nearest branch of the mutual fund house and fill the offline application form by attaching copy of the requisite documents.

Tax on Debt Funds

Long-term capital gains on debt fund are taxable at 20% after indexation. Indexation is a method of factoring the rise in inflation between the year when the debt fund units were bought and the year in which they were sold.

Short-term gains on debt funds are added to your taxable income and are taxed depending on income tax slab.

Debt funds return:

Following are the factors influencing returns on debt funds:

  • Type of debt funds invested
  • Tax slab that you fall under
  • Rate of inflation/deflation
  • Market rates
  • Investing in SIPs or not
  • Dividends
  • Exit load charges

Best Short term debt funds

The table below shows the top short term debt funds in India:

Mutual Fund House CRISIL RANK RISK
HDFC Short Term Debt Fund (G) Rank 1 Moderately low
IDFC Bond Fund - MTP (G) Rank 1 Moderately
L&T; Short Term Bond Fund (G) Rank 1 Moderately low
Kotak Corporate Bond Fund - D (G) Rank 1 Moderately low
HDFC Short Term Debt Fund (G) Rank 1 Moderately
HDFC Short Term Debt Fund - D (G) Rank 1 Moderately low
IDFC Bond Fund - MTP - D (G) Rank 1 Moderately
L & T Short Term Bond Fund - D (G) Rank 1 Moderately low
IDFC Bond Fund - STP - Direct (G) Rank 2 Moderately low
Kotak Dynamic Bond Fund (G) Rank 2 Moderately low

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