What is a Debt Mutual Fund?

Debt mutual fund investment scheme primarily invest in fixed-income securities such as government bonds, corporate bonds, money-market instruments, and other debt instruments. They aim to generate regular income and capital preservation rather than high growth.

Key Characteristics:

• Invest 75–100% in debt and money-market instruments
• Much Lower volatility and lower risk compared to equity funds
• Ideal for conservative investors seeking predictable returns

Types of Debt Mutual Funds

Category	Description
Liquid Funds	Invest in ultra-short maturities (up to 91 days); high liquidity; low risk
Ultra Short Duration Funds	Duration ~3–6 months; slightly higher returns than liquid funds
Low Duration Funds	Duration 6–12 months; moderate interest-rate risk
Money Market Funds	Instruments up to 1 year; similar to liquid/ultra-short; used for temporary parking of funds
Short Duration Funds	Duration 1–3 years; balanced between yield and interest-rate risk
Medium Duration Funds	Duration 3–4 years; higher interest-rate sensitivity
Long Duration Funds	Duration >7 years; highest interest-rate risk; suitable if rates are expected to fall
Dynamic Bond Funds	Actively adjust portfolio duration based on interest-rate outlook
Corporate Bond Funds	Invest predominantly in high-rating corporate bonds
Credit Risk Funds	Invest in lower-rating corporate bonds to earn higher yields; higher credit risk
Gilt Funds	Invest in government securities only; no credit risk, but interest-rate risk varies with duration
Gilt Funds with 10-Year Constant Duration	Target 10-year government bonds; highly sensitive to rate changes
Fixed Maturity Plans (FMPs)	Close-ended, fixed tenure funds; invest in debt matching maturity to fund’s tenure

Risks in Debt Mutual Funds :

Risk Type	Impact Description	Mitigation Tips
Interest Rate Risk	NAV falls when rates rise; higher with longer maturities	Choose appropriate duration based on outlook
Credit Risk	Default/downgrade leads to price fall	Check credit quality; prefer high-rated bonds
Liquidity Risk	Difficulty in selling securities at fair value	Invest in funds with liquid portfolio
Reinvestment Risk	Lower interest rates at reinvestment reduce returns	Diversify maturity profile
Concentration Risk	Heavy exposure to few issuers/sectors increases risk	Ensure diversified portfolio
Inflation Risk	Inflation reduces real returns	Mix with equity or inflation-indexed assets

Taxation of Debt Mutual Funds 

Pure Debt Funds or Mutual funds with less than 35% in equity shares.

For investments made before April 1, 2023:

• Short-Term (held ≤ 36 months): Gains added to income, taxed as per your income tax slab.
• Long-Term (held > 36 months): 20% tax with indexation benefit.

For investments made on or after April 1, 2023:

• All gains, regardless of holding period, are treated as short-term and taxed as per your income tax slab. No indexation benefit is available. 
• No indexation benefit
• No LTCG exemption

Who should choose Debt Fund?

Ideal Investors:

• Conservative Risk Profile: Prioritise capital preservation over high returns.
• Short- to Medium-Term Goals: 1-3 year horizons (e.g., emergency fund, down payment).
• Regular Income Need: Seeking periodic interest payouts via dividends or SWP (Systematic Withdrawal Plan).
• Portfolio Diversification: Reduce overall portfolio volatility by balancing equity exposure.

When to use which Category?

• Cash Parking (days–months): Liquid or ultra-short funds
• 1–3 Year Horizons: Short or low-duration funds
• 3–7 Year Horizons: Medium- to long-duration funds or dynamic bond funds
• Interest-Rate Views:
  • Expecting rates to fall → Long-duration or gilt funds
  • Expecting rates to rise → Short-duration or money-market funds
• Credit Yield Seeking: Corporate bond and credit risk funds (for higher yields with some risk)

Summary:

Debt funds provide stable returns and lower volatility compared to equities. By selecting the appropriate category—based on investment horizon, interest-rate outlook, and risk appetite—investors can meet goals such as liquidity management, regular income, and capital preservation while benefiting from mutual funds’ professional management and tax efficiency.

Regards,

Honvest Team.