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A Comprehensive Guide to Types of Debt Funds
For many retail and HNI investors, investing in debt funds is one of the primary options which gives them a chance to earn through fixed-income securities. In this article, we will cover different types of debt funds and the ways to invest in the right one.
What is a Debt Fund?
A debt fund is a mutual fund scheme that mainly allocates money to fixed-income instruments such as:
- Government bonds
- Corporate bonds
- Treasury bills
- Other money market instruments
Instead of purchasing a share of company (like with stocks), you’re essentially lending money to the issues of the debt in exchange for regular interest payments. Investors often prefer to invest in debt funds for regular income through capital growth and interest income.
Read More: What is Debt Fund
Types of Debt Funds
There are different types of debt funds in mutual funds category, which are based on the type of securities they invest in and the tenure of the securities in the portfolio, as explained below:
1. Based on Maturity/Duration (SEBI’s Primary Classification)
|
Debt Fund Type |
Duration/Maturity |
|
Overnight Funds |
Overnight securities having maturity of 1 day |
|
Liquid Funds |
These debt fund schemes invest in debt and money market instruments that mature within 91 days. |
|
Ultra Short Duration Funds |
Invests in debt and money market securities, maintaining a Macaulay duration ranging from 3 to 6 months |
|
Low Duration Funds |
Investment in Debt and Money Market instruments with Macaulay duration portfolio between 6 to 12 months. |
|
Money Market Funds |
Invests in short-term money market instruments with maturities of up to one year, offering liquidity and stability. |
|
Short Duration Funds |
These funds aim for a balance between risk and return by investing in debt and money market instruments with a Macaulay duration between 1 to 3 years. |
|
Medium Duration Funds |
They allocate assets across debt and money market instruments, with a portfolio duration ranging from 3 to 4 years |
|
Medium to Long Duration Funds |
Focused on higher returns, these funds hold debt instruments with a portfolio duration of more than 4 years, suitable for investors with a longer-term outlook. |
|
Long Duration Funds |
Aimed towards long-term investors, these funds include debt and money market instruments with a Macaulay duration exceeding 7 years. |
2. Based on Investment Strategy or Security Type
|
Debt Fund Type |
Strategy |
|
Dynamic Bond Funds |
These funds actively adjust their portfolio duration based on changing interest rate scenarios, offering flexibility across market cycles. |
|
Gilt Funds |
Primarily invest at least 80% of assets in government securities across varying maturities, making them low credit-risk options. |
|
Gilt Fund with 10-year constant duration |
This category requires at least 80% allocation to government securities, maintaining a steady Macaulay duration of exactly 10 years. |
|
Corporate Bond Fund |
These focus on high-quality corporate debt, investing a minimum of 80% in bonds rated AA+ and above. |
|
Credit Risk Funds |
Allocate investments to corporate bonds rated AA or lower, targeting higher returns with increased credit risk exposure. |
|
Banking and PSU Fund |
These funds exclusively invest in debt instruments issued by banks, public sector undertakings, public financial institutions, and municipal bodies. |
|
Floater Fund |
Minimum 65% in floating rate options. |
Also Read: How is debt fund taxed in 2025-26?
How to Choose the Right Debt Fund?
Now that you know how a debt fund works and its types, it’s important to pick the right debt fund that matches your needs. Before you invest in a debt fund, consider these parameters:
Match Fund Duration with Investment Horizon
One of the most significant factors when choosing from different types of debt funds is maturity profile of the scheme. The best debt mutual funds for long term are the ones invested in PSUs and Government securities such as Gilt Fund with 10-year constant duration. There are also short-term debt funds varying from overnight to few months if you have any specific financial goals.
Risk Appetite
Although debt funds mostly invest in fixed income securities, they carry risk that can be affected by factors such as market trends, investment strategy and nature of the securities. If you have high risk appetite, consider investing in longer duration debt funds. And for low to moderate risk-taking investments, consider short term debt fund investments.
Understand Credit Risk
Credit risk is the chance that the issuer might fail to pay back the interest or the principal amount on time. Debt instruments are rated by credit rating agencies based on this risk level. Check the rating for a debt fund to know it’s quality.
Examine Past Performance
The past performance of debt fund can provide evidence for how the fund is managed and what returns it could provide in the future. Although not the most reliable indicator for future returns, it can show whether the fund has been able to provide consistent returns through market fluctuations or not.
Check Expense Ratio and Fund Manager Reputation
The expense ratio reflects the yearly cost you incur for managing the fund. A lower ratio helps retain more of your returns. Also, consider the track record of the fund manager, as their decisions significantly influence fund performance.
Average Maturity and Yield to Maturity (YTM)
Check the fund’s average maturity to see how long it will take on average, for its investments to mature. YTM (Yield to Maturity) gives an estimate of the return you could earn if you hold the fund till maturity, assuming no defaults.
Conclusion
Debt funds provide diversified options for every risk profile and investment timeline, making them a flexible choice for building a balanced portfolio. By understanding the fund’s strategy, duration, and underlying securities, investors can make more informed choices. With a DBS Treasures Premium Savings Account, you also gain access to expert wealth management that helps you align the right debt fund with your financial goals.
Disclaimer: Mutual fund investments are subject to market risks. Please consult a financial advisor before investing.
