In the debt fund category, there are many sorts of schemes that are classified based on the type of securities they invest in and the duration of the instruments in the portfolio, as detailed below:
1. Money Market & Liquid Funds:
Retail investors’ primary investment option for storing excess cash has been savings bank accounts. Most investors consider these to be their only options, while others believe that storing excess funds elsewhere will erode their value and give no liquidity.
A new study highlights a more appealing option: Liquid Fund / Money Market Mutual Funds. The research shows that surplus cash placed in money market mutual funds earns excellent post-tax returns while maintaining an acceptable level of principal safety and liquidity.
Liquid Funds invest primarily in extremely liquid money market instruments and short-term debt securities, providing high liquidity. To achieve optimal returns while ensuring safety and liquidity, they invest in very short-term products such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates of Deposit (CD), and Collateralized Lending & Borrowing Obligations (CBLO) with residual maturities of up to 91 days.
These funds process redemption requests in one working day (T+1).
2. Income Funds:
They invest primarily in debt instruments of various maturities that are consistent with the funds’ objectives, with any residual funds being invested in short-term products such as Money Market instruments. These funds often invest in products that have a medium to long-term maturity.
3. Short-Term Funds:
Short-term debt funds invest in debt instruments with a shorter maturity or length than long-term debt funds. Debt and money market instruments, as well as government securities, make up the majority of these. These funds have a longer investment horizon than liquid funds but are shorter than medium-term income funds.
4. Floating Rate Funds (FRF):
FRFs are a type of income fund that invests in fixed income debt products such as bonds, debentures, and government securities, whereas income funds invest in fixed income debt instruments such as bonds, debentures, and government securities. FRFs generally invest in products with floating interest rates.
The Mumbai Inter-Bank Offer Rate (MIBOR), which is the benchmark rate for debt instruments, is usually tied to floating-rate securities. The interest rate is reset regularly based on the movement of the interest rate. The goal of FRFs is to provide investors with consistent returns that are consistent with market interest rates.
5. Gilt Funds:
The term ‘gilt’ refers to government-issued securities. A gilt fund invests in government securities issued by the federal and state governments over a variety of periods. Because the government is the issuer of the securities, these funds are generally risk-free. Gilt funds invest in Gilts that are either short-term or long-term in maturity. Depending on their maturity profile, gilt funds carry a significant level of interest rate risk.
The larger the interest rate risk, the longer the maturity profiles of the instruments are. (Interest rate risk refers to the influence of rising and falling interest rates on the market price of debt instruments. When interest rates fall, market prices of debt instruments rise, and vice versa.)
6. Interval Funds:
The features of open-ended and closed-ended mutual funds are combined in an interval fund, which is open for subscription and redemption only during specified transaction periods (STPs) at pre-determined intervals. In other words, Interval funds only accept Unit redemptions during STPs.
As a result, between two STPs, are similar to closed-ended schemes and must be registered on stock exchanges. Interval funds, unlike traditional closed-ended funds, do not have a maturity date and are thus open-ended.
As a result, one can keep their money in an Interval Fund for as long as they want to like open-ended schemes. Interval funds are thus similar to Fixed Maturity Plans (FMPs) with roll-over capability in that they allow investments to be rolled over from one period to the next.
Interval funds are primarily debt-oriented investments, but they can also invest in equities if the scheme’s investment objective and asset allocation are indicated in the Scheme Information Document.
Depending on whether the underlying portfolio is mostly invested in stocks or debt securities, interval funds are taxed similarly to other mutual funds. The fund is taxed as a non-equity fund if it invests 65 percent or more of its assets in debt instruments.
7. Multiple Yield Funds:
Multiple yield funds (MYFs) are debt-oriented hybrid funds that invest primarily in debt instruments, and to a lesser extent, in dividend-paying stocks.
Debt instruments can generate profits with less risk, while equities help with long-term capital appreciation. MYFs primarily invest in short-to-medium-term debt and money market securities with short-to-medium-term residual maturities.
8. Dynamic Bond Funds:
DBFs invest in a variety of debt securities with varying maturity characteristics. These funds are actively managed, and the portfolio changes dynamically depending on the fund managers’ interest rate outlook. These funds allow the fund manager to invest in short- or long-term instruments depending on his expectations for interest rate movement.
DBFs employ an active portfolio duration management technique, which involves keeping a careful eye on a variety of domestic and global macroeconomic indicators as well as interest rate forecasts.
9. Fixed Maturity Plans (FMPs):
FMPs are closed-ended debt mutual fund schemes that have a pre-determined maturity date (similar to a term deposit). FMPs that invest in debt instruments with a maturity date that is less than or equal to the scheme’s maturity date are considered debt funds. The investment is redeemed at the current NAV, and the maturity proceeds are returned to the investors after the maturity date.
An FMP’s term might last anywhere from 30 days to 60 months. Because the maturity date and amount are known ahead of time, the fund manager can invest in securities having a comparable maturity as the scheme with reasonable confidence.
If the scheme’s term is one year, the fund manager will invest in debt instruments that maturity immediately before the end of the year. Premature redemptions are not permitted in FMPs, unlike other open-ended funds where units can be bought and sold continuously.
As a result, the units of FMPs (which are closed-ended schemes) are required to be listed on a stock exchange/s so that investors can sell the units on the stock exchange in the event of a liquidity emergency.
10. Monthly Income Plans (MIPs):
MIPs are hybrid mutual fund schemes that invest in both debt and equity securities, however; they are often debt-oriented mutual fund schemes because they invest primarily in debt securities and just a minor amount (15-25%) in equities.
MIPs provide consistent income in the form of monthly, quarterly, or half-yearly dividend payments. As a result, MIPs are the favored solution for investors seeking consistent income streams.
Monthly income or a regular dividend is not guaranteed or required under MIP’s because the income is paid at the discretion of the mutual fund and is contingent on the availability of distributable surplus from realized gains.
MIP returns can be variable and may suffer losses as a result of the equity exposure, causing dividend payments to be erratic – both in terms of amount and frequency, or perhaps skipping dividend payments entirely. Despite this, MIPs have a track record of giving larger returns after-tax, so they may be a better option.
Investors who are concerned about MIP dividend income fluctuating can choose Growth Option and a systematic withdrawal plan, or SWP, which allows periodical redemption of a pre-determined amount. An SWP that is part of a MIP can provide investors with a steady stream of income. When a person invests a substantial amount of money, SWP works better.
11. Capital Protection-Oriented Fund Scheme:
Capital Protection-Oriented Funds (CaPrOF) are mutual fund schemes that attempt to protect at least the capital, i.e., the initial investment, while also allowing for further gains based on the fund’s investment objectives.
In a nutshell, it tries to protect the principal while also providing the possibility of equity-linked capital appreciation. It is crucial to realize, however, that there are no guarantees of returns or capital protection.
Capital Protection-Oriented Funds are closed-ended debt funds that typically invest a large percentage of their assets (say, 80%) in AAA-rated bonds and the rest in risky assets such as equity. To hedge against the downside risk, certain funds may invest in stock derivatives.
It is precisely this structure that is aimed toward safeguarding the principal. The debt half of the fund grows to return your capital at the end of the term, while the equity portion provides potential upside.
As a result, even if the stock market crashes, the capital amount is safe. Capital Protection-Oriented Funds are, hence recommended over conventional FMPs. Capital Protection-Oriented Funds are perfect for individuals who want to protect their money against downside risk while also participating in the stock market.
Read Next: “8 Common Myths of Mutual Funds.”
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