Debt Funds: Best Debt Mutual Funds to Invest in 2023

A debt fund is a category of mutual funds that generates returns by investing in several fixed-income instruments like government or corporate bonds, treasury bills, commercial papers, and certificates of deposits. 

Debt mutual funds offer low-risk and predictable returns to their investors over the investment period. With Debt MFs, you can earn returns in two ways- firstly through interest payments from the bond holdings and secondly the capital gain that results from price change of underlying instruments.

Continue reading to know more about the best debt mutual funds to invest in 2023!

List of Top Performing Debt Funds in India

Here are 10 of the top debt mutual funds to choose from in 2023: 

Name of the fund3-Year Compound Annual Growth Rate (CAGR)*
ICICI Prudential Credit Risk Fund – Direct Plan – Growth 8.34%
Axis Strategic Bond Fund – Direct Plan – Growth7.65%
ICICI Prudential Short Term Fund – Direct Plan – Growth 7.40%
UTI Treasury Advantage Fund – Direct Plan – Growth7.28%
Aditya Birla Sun Life Short Term Fund – Direct Plan  – Growth 7.22%
Sundaram Corporate Bond Fund – Direct – Plan Growth6.87%
Tata Dynamic Bond Fund – Direct Plan – Growth6.86%
PGIM India Corporate Bond Fund – Direct Plan – Growth6.77%
Axis Banking & PSU Debt Fund – Direct Plan – Growth 6.45%
Kotak Bond Fund – Direct Plan – Growth6.33%

*The figures are valid as of August 2nd 2022. 

How Do Debt Mutual Funds Work?

A debt mutual fund pools money from individuals before investing it into the debt securities of various companies and the government. Here are the multiple aspects of a debt mutual fund:

  • Fund manager: The managers of debt funds primarily invest a significant amount of the investible corpus in debt market instruments such as bonds and treasury bills. The manager ensures to invest in debt instruments with high credit-rating as they are more likely to pay regular interest as well as the principal upon maturity. 
  • Net Asset Value: The NAV of these funds reflects the valuation of securities associated with debt funds. It is dynamic and keeps on changing as per the market conditions. The difference between the purchase and selling price of these funds reflects appreciation or depreciation in their Net Asset Value. 
  • Sources of Income: There are two sources of return in a debt mutual fund – interest income and capital gains.  Securities in a debt MF provide a regular interest income which is either distributed among investors or added to the fund assets, thus increasing the NAV. Capital gains are the profit received from the sale of mutual fund units. 

Read More: Dynamic Bond Funds: Definition, Benefits, Risk and Things to Consider

Let’s understand the working of a debt mutual fund with an example:

The fund manager of a debt mutual fund uses the investible corpus to buy various types of debt securities like corporate or sovereign bonds. 

The changes occurring in the market interest rates influence the bond prices leading to capital gains or losses against the fund’s portfolio. A rise in interest rates in the market will lead to a fall in the price of debt securities, thus lowering the value of these funds. This will lead to a fall in the NAV of the debt funds, resulting in capital losses for the investors. 

On the other hand, a fall in market rates will increase the demand for the fund’s underlying securities and result in a corresponding rise in its prices. This phenomenon will increase the NAV of these funds and provide gains to the investors.    

However, the interest earned or the value of the capital gains or losses depends on the type of debt funds one invests in. 

Types of Debt Mutual Funds

The different types of debt mutual funds are as follows: 

  • Liquid Funds

These funds invest in various debt and money market instruments having a tenure of less than 91 days. As the name suggests, these mutual fund schemes come with high liquidity along with decent returns. 

  • Ultra Short Duration Funds

These debt mutual funds invest in securities having a maturity period of 3-6 months. They generally offer a higher interest rate than liquid funds. So ultra-short duration funds are ideal for parking your surplus funds which are not required in the next 3-6 months.

  • Overnight Funds

These funds invest in securities having a maturity of one day. These offer the highest form of liquidity to mutual fund investors. Overnight funds come with minimal or nil credit risk and offer stable returns to their investors. 

  • Short Term Funds

These mutual funds invest in debt securities having a maturity period of 1-3 years, thus making them a medium-term investment option. While Short-term funds mainly invest in short term securities, a part of their corpus is also allotted to longer-term securities.

This is another debt mutual fund which invests its corpus in debt securities whose maturity is in line with the tenure of the mutual fund scheme. Fixed maturity plans can have a maturity period of a few months to a few years, depending on the type of underlying security. 

  • Long Term Funds

Investments made in securities having a maturity period of more than seven years come under the long term funds. These funds primarily benefit from changes occurring in interest rates as any fall will increase the bond prices and, thereby, the NAV of mutual fund units also increases. 

  • Gilt Funds

A major characteristic of gilt funds is that they invest in government securities. This makes it ideal for investors who are looking for stability over returns. As government securities have sovereign backing, these come with nil or negligible credit risk.

Read More: Gilt Mutual Funds: List of Best Gilt Funds, Risk and Returns

  • Dynamic Bond Funds

These funds are characterised by flexible investment tenures. It is an open-ended fund whose corpus is invested in debt securities with varying maturities. Fund managers manage these funds actively. 

  • Money Market Funds

Money market funds are essentially open-ended funds that invest in money market securities such as dated securities, certificates of deposits, T-bills, etc. They have a maturity period of up to a year.

  • Floating Rate Funds:

Floating rate funds invest 65% or more of their portfolio in floating rate debt instruments. A floating rate instrument does not have a fixed coupon rate, and instead has a variable or floating interest rate. When the RBI hikes interest rates, while other debt funds may face adverse consequences, floater funds are likely to benefit. This is because every floating rate instrument has a specific benchmark and their rate changes in accordance with a change in the benchmark rate. So when RBI hikes the interest rate, the interest rate of these floater funds also increases. 

  • Corporate Bond Funds:

Corporate Bond funds invest at least 80% of their assets in high-rated corporate bonds that have a credit-rating of AA+ and above. Companies with high credit ratings are financially strong and have a high chance of repaying the lenders on time. However, a top-rated company can also default on its debt.

  • Banking and PSU Funds:  

These debt funds invest predominantly in Banks, Public Sector Undertakings and Public Financial Institutions. Debt and money market instruments issued by these institutions are usually of high credit quality, thus making these funds relatively low-risk. 

  • Credit Opportunity Funds

Also known as credit risk funds, fund managers of these mutual funds invest in low-rated corporate debt securities which have a high credit risk. However, the returns offered to investors can be quite high as compared to other debt mutual funds.

According to SEBI guidelines, these funds must invest at least 65% of their total corpus in corporate bonds or debt instruments having a credit rating lower than AA+. Investors who are looking for aggressive returns and have a high risk tolerance may pool their resources in these funds.   

Also Read: First-time Taxpayer? Understand everything about Income Tax Rebate

Benefits of Investing in Debt Mutual Funds

Here are some features of the best debt mutual funds that can benefit the investors:

  • Stable returns: One of the biggest advantages of investing in these funds is the stable returns that these funds offer to their investors. The predictable returns generated from these funds offer a sense of certainty to one’s portfolio. 
  • Liquidity: When compared to similar investment alternatives, debt mutual funds offer high liquidity to their investors. Individuals can encash their investment in case of an emergency. However, some debt mutual funds do carry an exit load for premature withdrawal. 
  • Cost effective: Debt mutual funds come with lower transaction costs than equity or hybrid mutual funds. Moreover, these funds do not attract TDS provisions which can reduce the overall disposable return to the investors. Debt MF’s short-term capital gains (if the units are sold before three years) are taxed as per your tax slab; and long-term capital gains are taxed at 20% with indexation. 
  • Diversification: Investing in the best debt mutual funds offer a great opportunity to diversify one’s investment portfolio. Only investing in equity-oriented funds can be a risky affair. Therefore, directing some of the investible corpora in debt funds helps to balance the overall risk of one’s investment portfolio.

Also Read: How Mutual Funds Work in India – Basics of Mutual Funds

Who Should Invest in Debt Mutual Funds?

Debt Mutual Funds are an ideal option for risk-averse investors who are looking for a stable and regular return. Investors planning to park their surplus funds for the short or medium term and gain considerable returns may go for debt mutual funds as the underlying securities usually have a low credit risk. 

Individuals wanting to generate higher returns than term or fixed deposits can opt for top performing debt funds as they offer stable returns and are more tax efficient than many other modes of investment.

Taxability of Debt Mutual Funds                          

Debt mutual funds are subject to taxation as per their period of holding. In case these funds are held for a period of less than 3 years, capital gains arising from these come under STCG or short term capital gains taxation. 

On the other hand, if you hold these funds over 36 months or 3 years, the gains are subject to LTCG or long term capital gains taxation. The taxation of STCG and LTCG has been highlighted below:

Holding PeriodTaxation
Short Term Capital GainsLess than 3 yearsTaxed as per the slab rate of the investor. 
Long Term Capital GainsMore than 3 yearsTaxed at a flat rate of 20% + Indexation benefit

The indexation benefit allows individuals to take inflation into consideration while computing capital gains. 

Things to Consider While Investing in Debt Mutual Funds

One must consider the following things before investing his/her hard earned money in debt mutual funds: 

  • Investment objectives

Before making an investment in a particular debt fund, individuals must analyse whether the fund will be able to fulfil their investment objectives. It is imperative for investors to make an investment strategy and then go ahead with the selection of the mutual fund scheme. 

  • Expense ratio

An expense ratio is the fees you pay for a mutual fund, including management fees, operating costs and transaction fees. The expense ratio of a debt mutual fund scheme directly affects the proceeds generated from the mutual fund. A higher expense ratio will lower the profitability of a mutual fund and vice versa. Therefore, investors must carefully analyse expense ratios of debt funds available in the markets before taking any investment decision. 

  • Past returns

Another factor that one should consider while deciding to invest in debt funds is past returns generated from these funds. Analysing the past performance of a mutual fund scheme gives us a fair idea about what we can expect from these funds.  However, one should keep in mind that past performance does not necessarily guarantee future returns.

  • Asset Allocation

One of the important factors to consider when selecting a mutual fund scheme is to look for the asset allocation of the scheme. In the asset allocation/portfolio of each scheme one can view the investments made in different organisations including corporates, government or public institutions. This helps in making an informed decision with our investment

  • Risk appetite

Every debt mutual fund comes with varying levels of risks. Therefore, one should analyse his/her risk appetite along with risk levels of a mutual fund scheme before taking an investment decision. 

If one has a low risk tolerance level, he/she may prefer low risk debt funds like overnight funds, liquid funds, etc. On the other hand, if an investor’s risk appetite is high, he/she may go for moderate or high risk funds like credit opportunity funds. 

  • Fund manager’s performance

A fund manager plays a critical role in the operation of a mutual fund. Every decision taken by the manager has a direct bearing on the fund’s performance. It is imperative for investors to critically analyse the fund manager’s past performance as it gives them an idea about the vision and strategy adopted by them. 

An individual can invest in a debt fund whose manager’s vision aligns with their investment objectives.

Final Word

Debt mutual funds are investment instruments that provide stable and predictable income to investors at a relatively lower risk than equity funds. It is more tax efficient than other modes of investment. This detailed guide about the best debt mutual funds in India will help individuals to make an informed decision before investing. 

Frequently Asked Questions

Are debt funds free from risk? 

No mutual fund investment is free from risk. The risk parameter varies from one type to another. Debt funds also carry risk, but it is low because it primarily invests in fixed-income instruments. 

What is an expense ratio?

Expense ratio is the fee that an asset management company levies on investors to cover the operating cost of a mutual fund scheme. Companies charge this a percentage value on the total amount invested by individuals. 

Do debt funds come with a lock-in period?

A debt mutual fund does not have a mandatory lock-in period. Therefore, these funds offer a great deal of liquidity to their investors.  

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The article may also contain information which are the personal views/opinions of the authors. The information contained in this article is for general, educational and awareness purposes only and is not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision, whether related to investment or otherwise, taken on the basis of this article.