Last Updated on Jun 14, 2022 by Nikitha

Investors aim to earn good returns on their investments. A good mix of different asset classes in an investment portfolio will help the investor achieve good returns with balanced risk. Most investors prefer equity and avoid debt in their portfolios. But even for an aggressive investor, having a fair share of debt in the portfolio will balance the risk. Debt mutual funds are low-risk instruments that will keep you covered during volatile times in the market.  

What are debt mutual funds? 

Mutual funds are one of the famous investment options in India. The need for limited risk mutual funds gave rise to debt funds. These are famously known as debt mutual funds, bond funds, or fixed-income funds.

Debt mutual funds invest in fixed-income instruments like bonds, government securities, treasury bills, short term plans and liquid funds. They provide steady income to the investors. As the investment involves fixed-income secure instruments, market fluctuations do not have much effect on the returns. Hence, debt mutual funds are ideal for investors looking for low-risk instruments.  

How do debt mutual funds work? 

As the name suggests, the funds in the debt funds are lent to the companies or the government. When a government or corporate entity needs liquidity, instead of borrowing from the bank or financial institution, they issue bonds. There is a fixed maturity date and interest rate determined on the bond at the time of purchase. Retail investors can invest in these securities through mutual funds. As per the predetermined terms, the investor gets the interest rate, and at the time of maturity, the principal investment is given back. 

The mutual fund managers carefully pick the debt securities such as corporate and government bonds, corporate debt securities, and money market instruments that offer capital appreciation and invest the capital. 

The important task of the fund manager is to find the right debt instrument by assessing the credit risk and picking underlying assets for the funds. As the underlying fixed income asset generates interest, the value of the fund goes up. Though the returns on the debt mutual funds are stable, they are not fixed. Any changes to the interest rates in the market can fluctuate the returns.

Types of debt mutual funds

Debt mutual funds are further categorised into several types according to the investment horizon, underlying assets and variability of returns. The different types of debt mutual funds are as follows. 

1. Overnight funds 

These are considered extremely safe funds, similar to savings accounts. The minimum maturity period on this fund is just one day.  

2. Liquid funds 

The investment is made in debt securities with a maturity period from 1 week to 91 days. Here the risk and returns both are low. 

3. Low duration funds

These offer reasonable returns, and the risk level is moderate. The maturity term on these funds is 6 months to 1 yr, which is slightly longer than the ultra-short duration funds. 

4. Ultra-short duration funds

The investment is made in the debt securities with a maturity period of 3 to 6 months. The returns offers are quite high as compared to the fixed deposits. 

5. Money market funds 

These are open-ended schemes where the capital is invested in money market instruments for a year.  

6. Short duration funds 

These funds invest in short-term instruments like short-term government bonds, corporate bonds, and debentures. The maturity period is 1 to 3 yrs. 

7. Medium duration funds 

Similar to the short duration funds, debt instruments are picked, but the maturity period is 3 – 4 yrs. 

8. Medium to long-duration funds

Here the investment is made in the debt securities with a maturity period of 4 to 7 yrs. These funds carry a bit higher interest rate risk. They tend to perform well when the interest rates are falling and vice versa. 

9. Long-duration funds 

The investment is made in long-duration debts with a maturity of more than 7 yrs. They carry higher risk as compared to any other funds mentioned above. But when compared to equity mutual funds, the risk is low. 

10. Corporate bond funds

While all the above-mentioned funds are differentiated according to the maturity period, the investment in the corporate bond funds is made according to the credit rating of securities. Cautious investors who are looking for safe and secured debt mutual funds can choose this.  

11. Banking and PSU funds

Here, at least 80% of the fund money is invested in banks, PSUs (Public Sector Undertakings) and public financial institutions (PFI).  

12. Gilt funds 

In these funds, 80% of the fund money is invested in government securities of different maturity periods. Though the default risk is low, the interest rate risk is high.

13. Gilt funds with a 10-year constant duration 

In these funds, 80% of the fund money is invested in government securities with 10 yrs’ maturity. 

14. Dynamic funds 

The investment is made in the debt instruments according to the interest rate movements in the market. The fund manager manages the portfolio as per the market situation. 

15. Credit risk funds 

In these funds, at least 65% of the fund money is invested in the below high-rated corporate bonds. As the ratings are average, the interest rate offered is high. Risk-averse investors can avoid choosing credit risk funds. 

16. Floater funds 

In these funds, a minimum of 65% of the fund money is put into the floating-rate bonds. Whenever the interest rate in the market changes, this fund’s interest also changes. 

17. Fixed maturity plan(FMP)

These are close-ended debt funds where the investment is made for a fixed period that could be months or years. This eliminates the interest-rate fluctuations in the market.    

18. Sectoral fund infrastructure (debt)

The funds are made in the infrastructure sector of the company. These can be sponsored by only non-banking financial companies (NBFCs) or corporates. 

19. Debt-interval fund 

These funds are a mix of closed-ended and open-ended instruments. The buy/sell of these funds can’t be done frequently. 

10 best debt mutual funds to invest in 2022 

Here’s the list of 10 best performing debt funds to invest in India, as of 07 June 2022. The parameters used to filter these best debt funds are as follows, 

  1. Category – Debt 
  2. Plan – Growth 
  3. CAGR 3 yr – set from high to low
FundsSub Category1 yr Returns (%)CAGR 3 yrs (%)CAGR 5 yrs (%)
UTI Dynamic Bond FundDynamic Bond Fund19.0510.255.73
HDFC FMP-XXVII-1846D-Aug 2013Fixed Maturity Plan6.379.508.44
UTI ST Income FundShort Duration Fund8.189.415.29
HDFC FMP-Sr 42-1487D-Aug 2018Fixed Maturity Plan6.169.459.17
PGIM India Short Duration FundShort Duration Fund2.608.784.61
DSP Strategic Bond FundDynamic Bond Fund2.079.136.58
Nippon India FHF-XXXX-16-1210DFixed Maturity Plan12.268.919.03
Nippon India FHF-XLI-4-1175DFixed Maturity Plan12.408.788.79
Nippon India FHF-XXXX-19-1184DFixed Maturity Plan12.918.808.84
Baroda BNP Paribas Credit Risk FundCredit Risk Fund12.878.637.53

1. UTI Dynamic Bond Fund

UTI Mutual Fund launched this scheme on 16 June 2010. As of 30 April 2022, the month-end AUM (Assets Under Management) is Rs 365.51 cr. and the expense ratio is 0.99%. The 3-yr and 5-yr CAGR are 10.25% and 5.73%, respectively. 

2. HDFC FMP-XXVII-1846D-Aug 2013

This fund from HDFC Mutual Funds was launched on 14 August 2013. As of 30 April 2022, the AUM is Rs 250.45 cr. and the expense ratio is 0.86%. The 3-yr and 5-yr CAGR are 9.50% and 8.44%, respectively. 

3. UTI ST Income Fund

This is one of the best short-term debt funds from UTI Mutual Funds launched on 22 May 2009. The month-end AUM on this fund, as of 30 April 2022, is Rs 2,509.77 cr., and the expense ratio is 0.35%. The 3-yr CAGR is 9.41%, and the 5-yr CAGR is 5.29%. 

4. HDFC FMP-Sr 42-1487D-Aug 2018 

This fund from HDFC Mutual Funds was launched on 03 September 2018. As of 07 June 2022, the AUM is Rs 824.05 cr., and the expense ratio is 0.25%. The 3-yr and 5-yr CAGR are 9.45% and 9.17%, respectively. 

5. PGIM India Short Duration Fund

This fund from PGIM India Mutual Funds was launched on 01 January 2013. As of 31 March 2022, the AUM is Rs 28.7 cr., and the expense ratio is 0.36%. The 3-yr and 5-yr CAGR are 8.78% and 4.61%, respectively. 

6. DSP Strategic Bond Fund 

This fund from DSP Mutual Funds was launched on 09 May 2007. As of 31 May 2022, the AUM is Rs 502.79 cr. and the expense ratio is 1.15%. The 3-yr and 5-yr CAGR of this fund are 9.13% and 6.58%, respectively. 

7. Nippon India FHF-XXXX-16-1210D

This fund from Nippon India Mutual Funds was launched on 21 February 2019. The AUM on this fund is Rs 36.01 cr. as of 31 March 2022, and the expense ratio is 0.7%. The 3-yr CAGR is 8.91%, and the 5-yr CAGR is 9.03%. 

8. Nippon India FHF-XLI-4-1175D

This debt fund from Nippon India Mutual Funds was launched on 28 March 2019. The AUM on this fund is Rs 45.7 cr. as of 30 April 2022, and the expense ratio is 0.68%. The 3-yr CAGR is 8.80%, and the 5-yr CAGR is 8.84%. 

9. Nippon India FHF-XXXX-19-1184D

This fixed maturity debt fund from Nippon India Mutual Funds was launched on 19 March 2019. The AUM on this fund is Rs 40.91 cr. as of 30 May 2022. The 3-yr CAGR is 8.63%, and the 5-yr CAGR is 7.53%. 

10. Baroda BNP Paribas Credit Risk Fund

This credit risk debt fund from Baroda BNP Paribas Mutual Funds was launched on 23 January 2015. The AUM on this fund is Rs 204.65 cr. as of 31 March 2022, and the expense ratio is 0.85%. The 3-yr CAGR is 8.63%, and the 5-yr CAGR is 7.53%.  

Should you invest in debt mutual funds? 

Debt mutual funds are well-suited: 

  • For risk-averse investors who are seeking regular income. 
  • For the investors who are looking for options to park their funds safely for a short period. 
  • For the first-time investors who are new to mutual funds and looking for low-risk instruments and a replacement for bank fixed deposits. 

How to choose the best debt mutual funds for you? 

Having several debt mutual funds options can be confusing for an investor. As not all debt mutual funds work in the same way, we’ve listed the way you need to choose the right one for you. 

1. Investor profile

An investor’s profile is a key factor before jumping on to any investment. It won’t be ideal for a person close to retirement to invest in a high-risk instrument. The fund scheme should be picked according to the investor’s goal and age.

2. Maturity period 

Most debt mutual funds vary according to the maturity period and this is the most important factor to consider as well. If you aim to invest for a shorter period of around 3 mth to 1 yr, then liquid funds could possibly be a better choice for you. Else if you are planning to stay invested for about 1-3 yrs can opt for short-term debt funds. Those with long-term objectives for about 3-5 yrs can pick medium-term bonds. 

3. Risk 

It is well-known that every investment carries at least a little amount of risk. Debt funds are exposed to interest-rate risk and credit risk. Hence it is essential to look into the history of the fund to avoid these risks. 

Taxes on debt mutual funds in India 

The taxation on the debt mutual funds in India depends on the holding period of the fund. For the short term investments, that is, if the investment is less than 3 yrs, then the returns will be added to the total income of the investor, and the rate of the tax will be levied as per the income slab of the investor. 

In the case of long term investments, that is, if the investment is more than 3 yrs, then the tax rate is 20% after indexation. The process of calculating the effect of inflation on an asset is called indexation.

FAQs

1. Are short-term debt funds better than long-term funds? 

If you have to meet your short-term goals then short-term debt funds can be a preferred option. It depends on the investor’s goal, risk appetite and time horizon. 

2. What are the best debt funds for 1 yr? 

You can check money market funds, which can be the best debt funds for 1 yr. The maturity period for the money market fund is 1 yr. 

3. Is there any lock-in period for the debt funds?

No. Unlike fixed deposits, there is no lock-in period for the debt funds.

4. What are the best debt funds for the long term?  

There are several types of debt funds for the long term. If the time horizon is 1 to 3 yrs then short-term funds are good. If the time period is long, about 3 – 4 yrs, then medium-term funds are preferred. If you are looking for debt funds with 4 to 7 yrs’ maturity, then medium to long-duration funds can be chosen, while, if the time period is more than 7 yrs then long duration funds can be chosen. 
However, it is important to remember that with the time period, the risk also increases. There can be credit risk, interest rate risk and inflation risk. But the debt mutual funds possess less risk as compared to equity mutual funds and can expect stable returns.

Nikitha