A debt fund is a mutual fund scheme that invests in a basket of fixed income instruments. Depending on the type of scheme, the portfolio could have bank CDs, commercial paper, corporate bonds, government securities and money market instruments or a combination of instruments. Some of the popular debt fund categories are overnight, liquid, ultra short term, medium duration, credit risk, dynamic bond and government securities funds.
How do debt funds score over traditional instruments?
Compared with a single instrument such as a bond, fixed deposit or nonconvertible debenture, debt funds help you diversify. A portfolio of a debt scheme has a number of papers that help mitigate single-party risks.
What are the tax liabilities in a debt fund? How does it compare on the liquidity metric?
There is no tax deduction at source (TDS) in debt mutual funds; and if held for three years, one can avail indexation benefit and minimize their tax outflow. Fixed deposits do not have indexation benefits. If there is a need to withdraw money, a debt mutual fund can be broken into units of `1 and investors can withdraw only the amount required. As compared to this, in a small-savings product or a fixed deposit, you would need to break the entire deposit.
What are the key risks in a debt fund?
Investors need to be aware of interest rate risks and credit risks. When interest rates rise, bond prices fall and vice versa, and the rate movements could make the NAV of the fund rise or fall. A credit risk is the risk of default on a debt security that may arise from a borrower failing to make the required payments. If any of the companies whose paper the fund owns does not pay up on due date, the fund’s NAV could suffer to the extent of the exposure.