People are reluctant to invest their hard earned money in mutual funds because they feel that they can lose out on the investment amount. They are convinced that all mutual funds invest in the stock market and hence carry a high investment risk. The fact remains that although mutual funds invest in equity and equity related instruments, they have designated fund managers who take calculated risk to allow the scheme to grow over the earns and in the process, help investors earn capital appreciation.
Mutual funds are further categorized as equity, debt, gold, ETFs, index etc. While equity mutual funds predominantly invest in equity and equity related instruments to generate capital appreciation, debt funds invest in fixed income securities and aim at offering stable returns with minimum investment risk.
What is a debt fund?
Whenever a debt instrument issuing company want to raise funds, they borrow from lenders and in exchange offer stable and consistent returns. This is basically how debt funds work. Investing in a debt fund is similar to lending money to the entity issuing debt instruments. A debt fund invests in fixed income securities such as government bonds, corporate securities, commercial paper, debentures, and other money market instruments. The investment objective of a debt fund is to offer capital appreciation that may not be as enticing as that offered by equity funds but something that is stable and consistent. Since the interest rate offered by these debt instruments is fixed and has a determined maturity period, they are known as fixed income securities.
How does a debt fund work?
Debt fund managers choose securities based on their credit ratings. Credit ratings rating implies the risk of default in paying the sum assured by the debt instrument issuer. A debt mutual fund’s fund manager has the responsibility of ensuring they invest in a diversified portfolio of ensures high rated credit instruments. A high credit rating means that the issuer has the potential to return the sum promised upon maturity and chances of them becoming a defaulter are very less.
Who should consider investing in debt funds?
Retail investors who wish to invest in mutual funds but do not want to expose their finances to the volatile nature of equity markets can consider investing in debt mutual funds. The investment portfolio of a debt mutual fund doesn’t get affected by the daily market vagaries. Investors who seek capital appreciation through investments in a diversified portfolio of debt instruments can consider adding debt funds to their mutual fund portfolio. Investors must understand that although the underlying securities of a debt funds don’t get affected by the fluctuations in the equity markets, they are prone to credit risk and interest rate risk.
Are all debt funds less volatile in nature?
Debt funds that invest in higher-rated securities are less volatile when compared to low-rated securities. Additionally, the maturity period may depend on the investment strategy of the fund manager. If there is a fall in the interest rates, the debt fund manager may have to invest in securities with a long term maturity. On the contrary, a fall in the interest rate will force the fund managers to invest in short term maturity securities.
Debt funds with longer maturity period are riskier than liquid funds and overnight funds that invest in fixed income securities with a maturity period of less than 91 days.
Debt funds may be less volatile than equity funds, but that doesn’t make them entirely risk free. Also, debt funds do not guarantee capital appreciation. Retail investors are expected to determine their investment goals and invest accordingly.