Debt mutual funds – investors’ ally for fixed income investments

Debt mutual funds – investors’ ally for fixed income investments

By Jiju Vidyadharan

Indians’ age-old romance with bank fixed deposits (FDs) appears to be souring in the backdrop of easing interest rates. The rate of interest offered by a one year FD  is currently trending at 6.75% versus 9.00% five years ago. In addition, FDs are not very liquid and flexible. On the other hand, debt mutual funds are gaining appeal precisely on these counts. They provide investors an opportunity to benefit from the broader debt market, based on their risk-return profile and investment horizon. Of course, being a mutual fund product, investors can enjoy all the other benefits, too, such as professional management, access to a diversified portfolio, convenience, and liquidity. Read on to find out how debt funds can be investors’ ally for fixed-income investments.

Ready reckoner

Debt funds invest in fixed-income instruments across the debt market. Investors can choose from a wide universe of debt funds based on their risk-return profile.

Product variant 
Liquid funds


These funds invest in debt market securities with maturity of less than 90 days and are a good option for investors who wish for returns higher than those of savings bank accounts with comparable liquidity. The recent introduction of instant redemption feature of up to Rs 50,000 from liquid funds is another plus in case you find yourself facing an unexpected cash crunch.
Ultra-short-term debt funds


These funds invest in debt securities which have a maturity of up to one year and are a good option for investors with an investment horizon of up to a year.
Fixed maturity plans (FMPs)These funds are closed-ended funds and invest in debt instruments having tenure equal to or less than the maturity of the fund. The tenure can be of different maturities, from one month to three years. As they lock in the investment at prevailing yields, they are less volatile to interest rate changes. These funds are listed on the stock exchanges and the route can be used to liquidate in the interim period if required albeit at a discount due to paucity of trading on the exchanges.


Short-term debt fundsThese funds invest in debt instruments having a short- to medium-term maturity of one year to five years. These funds can be invested for a horizon of one year to three years. As they are less sensitive to interest rate movements, they are less risky than duration-based funds.
Long-term debt fundsIncome and gilt funds invest in an underlying portfolio of long-term bonds and government securities, respectively. Typical investment horizon would be of more than three years, which provides indexation benefits (explained later). Being high on duration, these funds are more sensitive to interest rate changes, benefitting during periods of fall in yield.
Credit opportunity funds


These funds invest in papers rated below ‘AAA’ to earn higher yields. These are good for investors with a higher risk-return profile considering the higher risk associated with lower rated papers.

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Pros: Stable performance & indexation benefit

Debt mutual funds have historically been able to generate stable returns across periods analysed. Returns have outdone inflation (around 7 per cent historically), which is the biggest risk to real returns from fixed income instruments.

Performance (%)1










Long term maturity
CRISIL – AMFI Income Fund Performance Index8.1110.349.028.758.72
CRISIL – AMFI Gilt Fund Performance Index8.9511.789.788.828.30
3-year banks’ FD index8.218.758.848.668.37
Short-term maturity
CRISIL – AMFI Short Term Debt Fund Performance Index8.
CRISIL – AMFI Ultra Short Fund Performance Index7.738.438.698.678.12
CRISIL – AMFI Liquid Fund Performance Index6.717.778.298.347.76
1-year banks’ FD index7.478.248.578.398.08
Savings banks’ account3.973.994.003.953.82

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Annualised returns as on August 31, 2017

Additionally, debt funds score points by reducing the tax outgo when held for three years or more through the indexation benefit. Simply put, taxable returns from debt funds are reduced by inflation during the period to get the actual liability. In the above table, the long-term (10-year) return of 8.72 per cent (CRISIL-AMFI Income Fund performance index) would be reduced by inflation (7 per cent), and tax would be paid on residual returns as against taxation on entire returns from FDs.

Cons: Interest rate, liquidity and credit risks

Debt funds do not guarantee returns, they shadow the underlying market (marked to market). Further, these funds are subject to interest rate, liquidity and credit risks based on the category invested in. Hence, investors must map their investments based on their risk appetite. Further, investors should conduct due diligence on schemes before investing. They can refer to independent mutual fund rankings provided at as a guide to identify top performers for investment.

(The writer is Senior Director, Funds & Fixed Income, CRISIL Research)