Debt mutual funds often invest in a combination of debt and fixed-income assets. Government securities, money market instruments, corporate bonds with variable maturity dates, commercial paper, and so on are examples.
Debt funds have a defined interest-earning capacity and a set maturity time. In comparison to high-risk equities funds, which are exposed to market volatility, these funds are fundamentally low-risk investment channels.
However, keep in mind that even debt funds are not without risk. Unlike bank FDs, debt funds are also subject to credit and interest rate risk.
As a result, experts advise that before investing in debt funds, it is important to understand and analyze specific risks.
Things to Consider:
Interest rate risk – The change of interest rates has a significant influence on the valuation of debt mutual funds. According to experts, because debt mutual funds invest largely in bond securities, lower interest rates translate into higher returns.
When interest rates are falling, for example, a fund manager would often choose long-term securities to lock in profits for a longer period of time.
Risk of credit – Default is likely if a fund manager invests in debt instruments with a poor credit rating. As a result, fund managers often invest in assets with a high credit rating. Furthermore, high-rated instruments are subject to fewer swings, lowering credit risk substantially.
Risk in the market – Certain debt mutual funds, such as dynamic bond schemes, are vulnerable to market risk. For example, portfolio managers regularly modify the investment mix and duration in response to interest rate fluctuations. As a result, if the fund manager’s predictions are incorrect, the investments may suffer a loss.
Along with the risks, the returns on debt funds include interest income and capital appreciation in the security value, whether for the short or medium term, depending on market circumstances and investment duration.
It is important to note that, like equities funds, the returns on debt mutual funds are not guaranteed and are determined by the fund’s NAV.
According to industry experts, investing in debt funds may help investors achieve a variety of financial objectives.
However, before investing in debt funds, be aware of the dangers involved.