Demystifying Debt Funds: A Beginner’s Guide to Debt Funds

In the world of investments, where choices are aplenty, and risks must be carefully weighed, debt funds, particularly the best-performing debt mutual funds, have emerged as a compelling option for investors seeking stability and consistent returns. These funds are investment vehicles that primarily invest in fixed-income securities, such as long-term bonds, and aim to generate stable returns by earning interest income from the underlying investments.

Whether you’re a novice investor exploring what a debt fund is or a seasoned financial expert, understanding the intricacies of debt funds in India is essential to harnessing their potential and safeguarding your financial future. This article will explore the debt mutual funds meaning, shedding light on their inner workings, benefits, and considerations.

List of Best Debt Funds in 2024

Here is the list of best debt funds for you to invest in 2024:

Debt Funds	Sub Category	AUM (In cr.)	Expense Ratio (%)	CAGR 3Y (%)	5Y CAGR
ICICI Pru Overnight Fund	Overnight Fund	₹9,178.76	0.10	127.55%	66.10%
Bank of India Credit Risk Fund	Credit Risk Fund	₹121.92	1.19	39.62%	10.55%
Aditya Birla SL Medium Term Plan	Medium Duration Fund	₹1,868.91	0.85	13.63%	9.58%
DSP Credit Risk Fund	Credit Risk Fund	₹193.16	0.40	10.98%	8.98%
Bank of India Short Term Income Fund	Short Duration Fund	₹75.59	0.50	12.83%	8.61%
Baroda BNP Paribas Credit Risk Fund	Credit Risk Fund	₹141.08	0.79	10.06%	8.59%
UTI Dynamic Bond Fund	Dynamic Bond Fund	₹450.56	0.70	11.64%	8.56%
ICICI Pru Credit Risk Fund	Credit Risk Fund	₹6,763.39	0.77	7.34%	8.27%
ICICI Pru All Seasons Bond Fund	Credit Risk Fund	₹12,666.98	0.59	7.17%	8.10%
UTI Short Duration Fund	Medium to Long Duration Fund	₹2,745.43	1.25	7.87%	8.10%

Disclaimer: Please note that the above list is for educational purposes only, and is not recommendatory. Please do your own research or consult your financial advisor before investing.

Note: The data on this list is from 23rd August 2024, and the data is derived from Tickertape Mutual Fund Screener.

🚀 Pro Tip: You can use Tickertape’s Mutual Fund Screener to research and evaluate funds with over 50+ pre-loaded filters and parameters.

Details of the Best Performing Debt Funds in India 

ICICI Pru Overnight Fund

ICICI Prudential Asset Management Company Ltd, a leading AMC in the country, manages this fund. The AMC is a joint venture between ICICI Bank and Prudential Plc, one of the UK’s largest players in the financial services sectors. The expense ratio of the fund is 0.10%. The fund does not have a lock-in period or an exit load. As of 23rd August 2024, the fund has assets under management of Rs.  9,178.76 cr, and its 3-yr CAGR is 127.55%. 

Bank of India Credit Risk Fund

This fund is managed by the Bank of India Investment Managers (formerly BOI AXA Investment Managers) is a wholly owned subsidiary of Bank of India, which was founded in 1906 as a banking services company and later nationalised in 1969. The expense ratio of the fund is 1.19%. The fund has an exit load of 4% in case it is exited on or before 12 months, an exit load of 3% above 12 months if exited on or before 24 months and an exit load of 2% after 24 months if exited on or before 36 months. There is no exit load charged after 36 months. 

Aditya Birla SL Medium Term Plan

The fund is managed by Aditya Birla Sun Life AMC Limited, a joint venture between the Aditya Birla Group and the Sun Life Financial Inc. of Canada. The expense ratio of the fund is 0.85%. There is no exit load on this fund for up to 15% units of the fund. In the case of the remaining units, a 2% exit load is charged if the fund is exited on or before a year, a 1% exit load is charged after a year in case it is exited on or before 24 months, and no exit load if the fund is exited after 24 months. 

DSP Credit Risk Fund

DSP Credit Risk Fund is a debt mutual fund offered by DSP Mutual Fund. This scheme, managed by Laukik Bagwe and Vivekanand Ramakrishnan, focuses on credit risk investments. The fund has an expense ratio of 0.40%. There is no exit load for up to 10% of the investment, and a 1% exit load is charged on the rest of the investment if the fund is exited on or before 12 months. There is no exit load if the fund is exited after 12 months. As of 23rd August, the fund has an AUM of Rs. 193.16 cr. 

Bank of India Short Term Income Fund

This short-term income fund is managed by Bank of India Investment Managers (formerly BOI AXA Investment Managers) is a wholly owned subsidiary of Bank of India, which was founded in 1906 as a banking services company and later nationalised in 1969. The expense ratio of the fund is 0.50%. There is no exit load for this fund. As of 23rd August 2024, the fund has an AUM of Rs. 75.59 cr., and a current NAV of Rs. 26.67. 

Baroda BNP Paribas Credit Risk Fund

The fund is managed by BNP Paribas Asset Management, a leading, global asset management enterprise that offers a comprehensive range of active, passive and quantitative investment solutions. The expense ratio of the fund is 0.79%. There is no exit load for up to 10% of the investment, and a 1% exit load is charged on the rest of the investment if the fund is exited on or before 12 months. There is no exit load if the fund is exited after 12 months. As of 23rd August 2024, the fund has an AUM of Rs. 141.08 cr. 

UTI Dynamic Bond Fund

This bond fund is managed by UTI AMC. The expense ratio of the fund is 0.71%. Sudhir Agrawal manages this debt fund. As of 23rd August 2024, the fund has an AUM of Rs. 450.56 cr. and a current NAV of Rs. 31.29. The fund does not have an exit load or a lock-in period. Additionally, the fund’s 3-yr CAGR is 11.64% and a 5-yr CAGR of 8.56%.

ICICI Pru Credit Risk Fund

ICICI Prudential Credit Risk Fund is one of the debt mutual fund schemes under ICICI Prudential Mutual Fund. Managed by Manish Banthia and Akhil Kakkar, this scheme offers investors an option within the debt category. The scheme focuses on credit risk, making it suitable for those seeking exposure to corporate bonds and other debt instruments. The fund has an expense ratio of 0.77%. As of 23rd August 2024, the fund has an AUM of Rs. 6,763.39 cr., and a current NAV of Rs. 32.38. 

ICICI Pru All Seasons Bond Fund

ICICI Prudential All Seasons Bond Fund is a debt mutual fund offered by ICICI Prudential Mutual Fund. Managed by Manish Banthia and Nikhil Kabra, this fund is designed to provide investors with a steady income through investments in debt instruments. The fund has an expense ratio of 0.59%. As of 23rd August 2024, the fund has an AUM of Rs. 12,666.98 cr., and a current NAV of Rs. 36.96. The fund does not have a lock-in period and charges an exit load of 0.25% only if the fund is withdrawn on or before 1 month. There is no exit load if the fund is withdrawn after a month. 

UTI Short Duration Fund

UTI Ultra Short Duration Fund is a debt mutual fund offered by UTI Mutual Fund. Managed by Ritesh Nambiar, this scheme focuses on providing investors with a short-term investment option. The fund has an expense ratio of 1.25%. As of 23rd August 2024, the fund has an AUM of Rs. 2,745.43 cr., and its current NAV is Rs. 31.38. The fund has no lock-in period and no exit load. Additionally, the fund has a 3-yr CAGR of 7.87% and a 5-yr CAGR of 8.10%.

What are Debt Mutual Funds?

Debt funds, also known as fixed-income funds, are mutual funds that focus on investments in fixed-income securities. These can include government bonds, corporate bonds, or even debentures. The main goal of these funds is to generate regular income for investors through the interest earned on these fixed-income investments.

The best thing about these funds is that they are generally considered less risky than other investment options. This is because they mainly invest in fixed-income securities with predetermined interest rates and maturity periods, offering a sense of stability and a higher likelihood of receiving steady returns.

However, no investment comes without risks. Investment in debt funds still bear their own level of risk. The value of these funds can fluctuate based on factors like changes in interest rates and the creditworthiness of the issuers. Hence, it’s always a wise strategy to carefully evaluate our investment goals and risk tolerance before diving into debt mutual funds.

How Do The Top Performing Debt Funds Work?

When you invest in a debt fund, your money is pooled together with funds from other investors. The fund manager then invests this collective pool in a diversified portfolio of fixed-income securities, such as government bonds, corporate bonds, and other debt instruments.

The income generated from these investments primarily comes in the form of interest payments and periodic coupon payments. The fund manager collects these payments on behalf of the investors and distributes them proportionately among the investors based on their share in the fund.

The value of a debt fund’s units is calculated based on the fund’s net asset value (NAV). The NAV represents the total value of the fund’s assets minus any liabilities, divided by the number of units outstanding. This metric provides an idea of how much each unit of the fund is worth, helping investors understand what a debt fund investment is and how debt funds work.

Types of Debt Funds

There are various types of debt mutual funds available to invest in, offering opportunities for how to invest in debt funds depending on your financial goals and risk tolerance. Let’s explore some of the common types:

Government Securities Funds

These investment vehicles primarily focus on government securities like treasury bills and bonds, often ranking as the best performing debt mutual funds due to their safety and stability. Backed by the government, these low-risk funds are ideal for investors seeking capital preservation with moderate growth, offering high returns at relatively lower risk.

Corporate Bond Funds

Corporate Bond Funds invest in corporate debt securities to offer income through interest from bonds with higher yields than government securities, accepting a slightly higher risk. These funds are often considered among the best debt funds for lumpsum investment due to their balance of risk and return, ideal for diversifying portfolios beyond equities and government bonds. They cater to investors with medium risk tolerance, aiming to boost portfolio yield via a spectrum of corporate debts, from investment-grade to high-yield, riskier bonds.

Liquid Debt Funds

Liquid Debt Funds cater to those prioritising safety and liquidity, aiming for returns marginally higher than savings accounts. Investing in short-duration, low-risk instruments like treasury bills, these funds provide easy access to funds with minimal risk, ideal for short-term income. Suitable for investors needing quick capital access without a lock-in period, they offer flexibility and stability for efficiently managing surplus cash or emergency funds.

Short-Term and Long-Term Debt Funds

These funds have portfolios with a mix of debt securities that have different maturity periods. Short duration funds or low duration funds have shorter maturities, usually up to three years, making them a prime choice for debt fund investment with a near-term focus. On the other hand, long duration funds or long term debt funds extend their maturities, ranging from three to ten years or more, appealing to investors with a longer investment horizon looking for long term bonds. Both types offer a range of options for those interested in debt investments, allowing for strategic asset allocation based on individual time frames and risk tolerance.

Ultra Short Term Debt Funds

Ultra short-term debt funds are a distinct category within the examples of debt funds, primarily investing in debt securities with an average maturity of less than one year. Known for their safety and liquidity, these funds provide investors with a low-risk investment avenue, ideal for best-performing debt fund seekers aiming for consistent returns. They are especially suitable for conservative investors interested in debt capital with fixed income expenses maturity, looking to mitigate interest rate risk.

Fixed Maturity Plans (FMPs)

FMPs are close-ended debt funds with a fixed maturity date, representing a unique debt fund investment strategy. They invest in debt securities that align with the fund’s maturity period, making them an attractive option for those searching for the best debt funds for lumpsum investment. FMPs offer a defined investment horizon and aim to provide predictable returns based on the fixed maturity period, appealing to investors who value certainty and are looking for good debt funds that match their specific financial goals.

Features of Debt Funds

Here are a few key features of debt funds: 

• Returns: Debt funds generate returns through interest income and the maturity proceeds of their debt securities. These fixed-income securities offer a steady cash flow with minimal exposure to market volatility.
• Risk: While debt funds are less volatile than equities, they are not risk-free. Interest rate changes can impact the fund’s value, and credit risk arises if the fund includes securities with lower credit ratings.
• Diversification: By including debt funds in a portfolio, investors can reduce their exposure to equity market risks.
• Taxation: Debt funds are tax-efficient. Taxes are payable only upon redemption. Holding the fund for less than three years incurs short-term capital gains tax, while holding it for more than three years qualifies for long-term capital gains tax and possible cost indexation benefits, which can reduce tax liability.
• Liquidity: Debt funds offer high liquidity, allowing investors to buy or sell at a publicly disclosed price any day, with no penalties for early withdrawal.

How Debt Funds are Different from Other Mutual Funds?

Debt funds, also known as fixed-income funds, differ from other mutual fund schemes primarily in terms of the underlying assets they invest in, their risk profile, and their return characteristics. Here’s a closer look at how debt funds stand apart:

Feature	Debt Funds	Equity Funds	Hybrid Funds
Type of Investments	Fixed-income securities like government bonds, corporate bonds, treasury bills, and commercial papers.	Stocks or equities of companies.	A mix of equities and fixed-income securities in varying proportions.
Risk Profile	Lower risk due to investment in securities offering fixed returns. Subject to interest rate, credit, and liquidity risk.	Higher risk due to market volatility. Potential for higher returns makes it suitable for those with a long-term horizon.	Moderate risk, falling between debt and equity funds depending on their asset allocation.
Return Potential	Steady and predictable returns, generally lower than equity funds but higher than traditional savings accounts.	Potential for higher returns over the long term, suitable for investors with higher risk tolerance.	Returns influenced by both the fixed income and equity components, aiming for moderate growth with reduced volatility.
Investment Objective and Suitability	Ideal for regular income, capital preservation, and lower volatility. Suited for short to medium-term goals.	Best for investors aiming for capital growth over the long term and can withstand market fluctuations.	Suitable for investors seeking a mix of income and growth with moderate risk, preferring a balanced investing approach.
Tax Treatment	Short-term gains taxed as per income tax slab, long-term gains taxed at 20% with indexation (for holdings more than three years).	Long-term capital gains taxed at 10% for gains exceeding ₹1 lakh without indexation, short-term gains taxed at 15%.	Taxation depends on the specific allocation to equity and debt; hybrid equity-oriented funds are taxed like equity funds, and debt-oriented like debt funds.

Who Should Invest in Debt Funds? 

Debt mutual funds present an attractive investment option for individuals seeking various benefits:

• Regular Income: A Debt fund offers a reliable source of income, making them ideal for those who rely on a steady cash flow for their expenses or supplement retirement income.
• Liquidity: With relatively high liquidity, debt funds allow investors to easily access their invested capital by selling the funds when needed, providing financial flexibility.
• Safety: While there is still some level of risk involved, debt mutual funds are generally considered safer than equity funds. This makes them appealing to individuals who prefer a more conservative approach to investing.

Here are some specific groups of people who can greatly benefit from investing in debt funds:

• Retirees: For individuals looking for a steady stream of income to cover living expenses in retirement, debt funds provide a stable income source. They are an excellent tool for those who need to preserve their capital while receiving regular payouts, aligning well with the goal of supplementing retirement income.
• Short-Term Goal Savers: Individuals saving towards imminent financial goals, like purchasing a house or a car, will find the relative safety and lower risk of debt funds advantageous. The liquidity aspect allows for quick access to funds when goals are met, making debt funds investment a prudent choice.
• Risk-Averse Investors: For investors prioritizing capital preservation over high-risk opportunities, debt funds offer a balanced approach. They cater well to those who are cautious yet looking for some level of growth or income generation without the volatility associated with equity investments.

How to Invest in a Debt Fund in India?

Here’s a guide on how to invest in debt funds in India :

1. Open a Demat and Trading Account: Essential for trading in the securities market, these accounts are your gateway to investing in debt mutual funds.
2. Choose a Debt Fund: With a plethora of debt funds in India, selecting one that aligns with your investment goals and risk profile is crucial. Utilise fund factsheets and performance comparisons as tools for making an informed decision.
3. Make a Lump Sum Investment or Start a SIP: Options for investment include a one-time lump sum investment or a Systematic Investment Plan (SIP), catering to both bulk investors and those preferring to invest gradually.
4. Review Your Investments Regularly: Regularly assessing your investment portfolio ensures alignment with financial goals, allowing for adjustments as needed.

Advantages of Debt Fund Investment 

Investing in a debt mutual fund comes with some great advantages. Let me break them down for you:

• Regular Income Generation: One of the key benefits of these funds is that they aim to provide you with a regular income stream. By investing in fixed-income instruments like government securities and corporate bonds, debt funds generate interest payments that can contribute to your income.
• Lower Risk Compared to Equity Investments: If you prefer a more conservative approach to investing, debt schemes can be a good option. They generally carry lower risk compared to equity investments, offering stability and potentially protecting your capital.
• Diversification Benefits: High return debt funds invest in a wide range of bonds issued by different entities. This diversification helps spread the risk across multiple issuers, reducing the impact of defaults on individual securities. It’s like not putting all your eggs in one basket!
• Liquidity and Flexibility: Need quick access to your money? Debt funds offer high liquidity, allowing you to buy and sell units at the prevailing NAVs. This flexibility gives you the freedom to manage your investments according to your financial needs.
• Potential for Capital Appreciation: While these funds primarily focus on generating income, they also have the potential for capital appreciation. Changes in interest rates can impact bond prices, creating opportunities for you to earn capital gains if you time your investments well.

Cons of Investing in Debt Funds

Debt fund investments have their own advantages, but it’s important to be aware of the potential disadvantages as well. Here are some key drawbacks to consider:

• Limited Growth Potential: Debt mutual funds typically offer more stable returns, but they may not generate high growth compared to riskier investments like shares. If you’re seeking substantial returns, debt mutual funds may not be the best choice.
• Debt Fund Interest Rate and Inflation Risks: Even the best debt funds in India are affected by changes in interest rates. When rates go up, the value of existing bonds in the fund can decrease, impacting your return on debt funds. Additionally, your purchasing power could be eroded if the fund’s returns don’t outpace inflation.
• Credit and Default Risks: These funds invest in bonds issued by various entities. There’s always a risk that issuers may default on payments. Higher-yielding securities often carry higher credit risks, so be mindful of the credit quality of the fund’s holdings.
• Liquidity Challenges: Some debt mutual funds, especially those with less liquid securities, may face difficulty selling assets during debt market downturns. This could affect your ability to exit the fund when needed.

Taxation on Debt Mutual Funds as per the 2024 Budget

Understanding the latest tax regulations on debt mutual funds is crucial for effectively managing your investments. The Union Budget 2024 has introduced significant changes to the taxation of debt mutual funds. Here is a detailed breakdown of the new tax rules:

Short-Term Capital Gains (STCG)

If you sell your debt fund units within three years (36 months), the gains from these investments are considered short-term capital gains. According to the new budget, these gains will be taxed according to your income tax slab rate.

Long-Term Capital Gains (LTCG)

For debt funds held for over three years (36 months), the gains are categorized as long-term capital gains. The key points to note under the new budget are:

• Tax Rate: The tax rate for long-term capital gains on debt funds is now a flat 12.5%, regardless of the amount of gain.
• No Indexation Benefit: The benefit of indexation, which previously allowed investors to adjust the purchase price of their assets for inflation, has been removed for debt funds. This means that the entire gain from selling a debt fund after three years will be taxable at the flat rate of 12.5%.

Summary

Capital Gains Tax	Description
Short-Term Capital Gains (STCG)	If you sell your debt fund units within three years (36 months), the tax will be as per your income tax slab.
Long-Term Capital Gains (LTCG)	For debt funds held for over three years (36 months), the tax rate is now a flat 12.5% without indexation benefits.

Tips for Investing in Debt Funds

If you are planning to invest in debt mutual funds, here are some tips on choosing the best debt fund to invest in:

• Define Your Investment Goals: Start by figuring out what you want to achieve with your investment. Are you looking for a steady income or long-term growth? Knowing your goals will help you choose the right funds that align with your financial objectives.
• Understand Your Risk Tolerance and Timeframe: Take a moment to assess how much risk you’re comfortable with and how long you can keep your money invested. Debt funds have different risk profiles and maturity periods, so it’s crucial to choose funds that match your risk tolerance and investment timeframe.
• Do Your Homework: Before diving into any investment, do your research. Look into different debt funds available in the market. Consider factors like historical performance, credit quality, expense ratios, and the expertise of the fund manager. This will help you make an informed decision.
• Keep an Eye on Fund Performance: Once you’ve invested, it’s important to regularly review how your chosen debt funds are performing. Keep track of their returns, fees, and any changes in their investment strategy or management team. Staying informed will empower you to make necessary adjustments when needed.
• Seek Professional Guidance: If you feel overwhelmed or unsure about navigating the world of debt mutual funds, don’t hesitate to seek professional advice. A financial advisor can provide valuable insights and personalised recommendations based on your unique financial situation and goals.

Factors to Consider Before Investing in Debt Funds

Here are the key factors to keep in mind:

• Risk and Return Profile: Take some time to understand the risk and return profile of the debt fund you’re considering. Every fund has its own level of risk and potential returns. So, it’s essential to figure out how comfortable you are with taking risks and choose a fund that matches your investment goals.
• Investment Horizon: How long do you plan to stay invested? Consider your investment horizon, whether it’s short-term, medium-term, or long-term. Different debt mutual funds have varying maturities, so it’s crucial to select one that aligns with your investment timeline.
• Expense Ratios and Fees: Don’t forget to look into the expense ratios and fees associated with the debt fund. A lower expense ratio can have a positive impact on your overall returns. Make sure to compare the costs involved and evaluate them against the fund’s performance.
• Credit Ratings and Portfolio Quality: Check the credit ratings and portfolio quality of the debt fund. Higher-rated securities generally indicate lower credit risk. It’s wise to review the fund’s holdings and diversification strategy to understand how they manage credit risk and generate consistent returns.
• Fund Manager Expertise: The expertise of the fund manager can play a crucial role in a fund’s performance. Take a closer look at the fund manager’s experience, investment philosophy, and track record. A skilled and experienced manager can make a real difference in delivering positive results.

To Wrap It Up…

Debt mutual funds offer a compelling investment option for individuals seeking stability, regular income, and diversification in their portfolios. With a focus on fixed-income securities, these funds provide an avenue for investors to earn interest income while mitigating the higher risks. 

Additionally, the flexibility and liquidity of debt funds make them suitable for both short-term and long-term investment horizons. However, it is essential to carefully evaluate factors such as credit ratings, expense ratios, and the fund manager’s expertise before investing.

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Frequently Asked Questions About Debt Funds