Debt Funds – Meaning, Types, Returns and Difference from Covered Bond

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With the rising number of investments in the debt market in the past few months, the returns and security of the assets are also improving.

 

There are a few securities that offer better returns at moderate risk. 

 

Let us understand in detail what debt funds are, types of debt funds, the returns they generate, and let’s also compare debt funds with covered bonds. 

 

What are Debt Funds?

 

A debt mutual fund is a type of fund that invests in debt securities offering fixed income. Debt securities such as bonds, treasury bills, debentures, fixed deposits, etc., are considered fixed-income securities. 

 

Debt funds are comparatively less riskier than other categories of mutual funds and fall under the low to moderate risk grade. They are usually recommended for short-term

Major Types of Debt Mutual Funds

1. Liquid Funds

 

Liquid funds invest in liquid instruments with a maturity of 91 days. These investments are recommended for short-term. They offer higher returns than a savings bank account.  

2. Dynamic Bond Funds

 

These invest in debt instruments which have different maturity periods. They are designed for investors that have a moderate risk appetite. 

3. Short Duration Funds

 

These mutual funds invest in debt securities where the duration of the scheme is between one to three years. 

4. Long Duration Funds

 

These mutual funds invest in debt securities where the duration of the scheme is more than 7 years. 

5. Gilt Funds

 

Such mutual funds invest majorly in high-rated government securities that do not carry any type of credit risk.  

7. Credit Opportunity Funds

 

Credit Opportunity Funds invest in low-rated securities where the potential to generate good returns increases due to increased risk. 

Returns Generated by Top Debt Mutual Funds

 

Top Debt Mutual Funds
Short-term Funds  5-Year Return Credit Opportunity Funds  5-Year Return Gilt Funds 5-Year Return
Nippon India Short-term Fund 8.04% ICICI Prudential Credit Risk Fund  9.00% Aditya Birla Sun Life Government Securities Fund 8.81 
HDFC Short-term Debt Fund 8.23% HDFC Credit Risk Debt Fund 8.78% IDFC GSF Investment  Fund  9.34%
ICICI Prudential Short-term Fund 8.52% Kotak Credit Risk Fund 8.01% Axis Gilt Fund 7.93%
Axis Short-term Fund 8.29% Axis Credit Risk Fund 7.73% DSP Government   Securities Fund 8.83%
Canara Robeco Short Duration Fund 7.86% SBI Credit Risk Fund 7.94% ICICI Prudential Gilt Fund 8.45%

Debt Mutual Funds Vs. Covered Bonds

 

Let’s analyse how debt mutual funds are different from covered bonds.

1. Volatility

 

As discussed earlier, debt mutual funds invest in debt securities and are comparatively less volatile than equity and hybrid mutual funds.

 

On the other hand, a covered bond is a fixed income security and it is basically a bankruptcy protected bond, which means, even if the NBFC defaults, there probability of an investor getting back his/ her principal and interest is very high.  

2. Returns

 

Debt funds mostly invest in fixed income securities, however, the fund manager can choose to invest some part of the allocation in equity or even keep it as cash. Therefore, their returns may vary. 

 

Covered bonds offered by Wint Wealth provide returns between the range of 9-11%. These covered bonds are offered by NBFCs and are available on the platform for investment. 

3. Risk Involvement

 

Debt funds primarily contain credit risk and interest rate risk. Credit risk relates to the non-payment of the invested amount (either principal or interest); interest rate risk means the interest rates can fluctuate.

 

Covered Bonds also involve three types of risks – credit risk, fraud risk, and liquidity risk. Credit risk involves the risk of an NBFC going bankrupt and non-payment from the borrowers. Liquidity risk means the risk of non-availability of the invested amount, incase one wants to withdraw it. Fraud risk relates to NBFCs fraudulently providing defaulters loans.

 

 

4. Taxation

 

Debt funds are taxed for the capital gains generated upon redeeming the fund’s units. Short-term capital gain is charged if the debt fund is held for less than three years, whereas long-term capital gain tax will be levied if the units are held for more than three years. 

 

The interest earned on covered bonds is charged under ‘Income from Other Sources.’ However, if a covered bond is structured as an MLD and the holding period is more than 12 months, then 10% LTCG will be charged. And if the period of holding is less than 12 months, then STCG will be charged as per your income tax slab. 

5. Suitability

 

Investors who have a low to moderate risk appetite can invest in debt funds. Debt funds are usually for investors who want to invest for a relatively short time period.

 

Covered Bonds are high risk – high return investment options and they are best suited for investors who want to diversify their portfolio through debt instruments. 

 

 

Conclusion

 

Now that you know about debt funds and their difference from covered bonds, which is another rising debt instrument, you will be able to make a better choice.

 

Remember to always consider your risk appetite and financial goals, before you make an investment strategy.

 

Happy Winting!

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