What is a Debt Fund?
- 25 February 2017 | 454 Views | By Mint2Save
A debt fund is a pool of investment or a mutual fund or exchange-traded fund that invest in fixed income securities such as treasury bills and bonds. Short term plans (STPs), liquid funds, gilt funds, monthly income plans (MIPs), and fixed maturity plans (FMPs) are some of the investment options in debt funds. Apart from these categories, debt funds include various types of funds investing in short term, medium term and long term bonds. Managing debt funds is not as glamorous a job as working with equity mutual funds, but it is an important job in spite of that, especially when it comes to protecting the principal investment of investors.
In debt markets and debt funds, the risk increases with a equivalence increase in maturity. The longer the maturity of fund, the greater the risk of valuation loss, as long maturity securities lose more in value when interest rates rise. In such a situation, it becomes difficult for investor to make a distinction between long-term and short-term funds.
Short term debt funds are meant for the investors who want to be invested for short term- less than 6 months. These short term debt funds invest in shorter dated paper like certificates of deposits (CDs), treasury Bills and commercial paper to name a few. They are primarily invested in debt instruments of a shorter tenure. Example – Templeton Income Short Term. If the investor has a short-term time horizon, then a short-term bond or a money market fund (liquid fund) would be most suitable, as the capital would be protected and the investor can enjoy current income without being bothered with the inexplicable change or with daily fluctuations of the bond market. Short–term debt funds are the fund that goes for longer maturities. The average maturity periods of short term funds portfolios will typically be around 2 years or 3 years. Any corporation can issue short-term debt, including governments, corporations rated investment grade, and companies rated below investment grade. Short- Term tend to have lower interest rate risk than long term, so they tend to hold up better when market conditions are unfavourable. Keep in mind, however, that you can lose principal in a short-term fund.
Moreover, short-term funds have modest share price fluctuation than money market funds maintain a stable at $1 share price. Money market funds offer fewer yields than short term bond funds. For this reason, short-term funds can be an alternative for those with a slightly longer-time investment horizon (2 to 3 years) that allows them to take on a modest degree of risk in exchange for a higher yield. They require a holding period around 2 years.
Short term funds can be used as a safety place for cash that won’t be needed for another two to three years. Short-term funds are highly liquid that enables investors easy access to their cash. If you have surplus money which needs to be invested for say a year, you can consider investing in these funds. They are less sensitive to rising inflation than long-term bonds.
Some short-term funds are also called income funds due to their strategy. These funds hold bonds to maturity and aim at earning interest income (or in finance-speak, an accrual strategy) across rate cycles. As Debt Funds mainly invest in debt securities, they are relatively more stable than equity investments. They can also lend stability to your equity portfolio by reducing the risk associated with your complete investment portfolio. In debt funds you have the freedom to withdraw your money as and when required.
Short term funds are most often primarily made up of corporate Bonds. During period of low interest rates, short term bond funds do not yield higher returns as it is cheaper for companies to raise funds from banks than to raise funds from the corporate debt market.