- Defining Debt Funds
- Understanding Facts that Matter!
- Defining How Debt Funds Work
- How Will it Affect You?
- Risks of Debt Funds
- Kinds of Debt Funds You May Invest In
- Overnight Funds
- Liquid Funds
- Ultra-Short-Term Funds
- Low Duration Funds
- Money Market Funds
- Medium to Long-Duration Funds
- Credit Risk Funds
- Why do We Invest in Debt Funds?
- The Bottom Line
Debt Fund Definition, Risk, How to Invest, Examples
Debt Funds are a conglomeration of mutual funds. The debt fund schemes invest in corporate bonds, money market tools, government bonds, debt securities, and other fixed-term tools.
These investments are safe as professional bodies like Asset Management control the funds. Hence, you may use these funds to Build Credit From Scratch: Learn in Details.
So, debt funds are safe for people who seek stability and reliability from investments.
Often, people consider debt funds as Liquid Funds.
However, liquid funds are invested in ultra-short-term funds like treasury bills or commercial papers. These funds can be a great source of slip-in earnings., read the Ultra-Short Bond Funds: Meaning, Credit Quality, and Examples article to know more.
Such funds have a tenure of 91 days.
Meanwhile, the debt funds invest in fixed-income funds. Their range may be a few days, months, or years.
Defining Debt Funds
You can perceive debt funds to be investment pools. However, all the individual funds under debt funds are fixed-term investment options.
An ICI research found that 120 million US citizens hold active mutual funds. However, mutual funds are a significant chapter in itself. To learn more, read the tricks of Demystifying Mutual Funds: Break down the concept of mutual funds, types, fees, risks, and benefits in simple terms. Most of these are fixed-term funds. In comparison, Liquid funds are rare.
People prefer debt funds for ample reasons.
Firstly, they are flexible. Both short and long-term debt funds are available in the US.
Secondly, debt funds combine bonds, securities, money market instruments, and other investment options to choose from.
Thirdly, the debt funds have a lower fee ratio. As a result, fund management costs are lower than those of liquid funds.
Check out three debt funds with the lowest expense ratio for your convenience.
Understanding Facts that Matter!
- Debt Funds are mutual funds. Instead, they are pools of funds. You may also call them ‘exchange-traded funds (ETF).’
- They are one of the best-pooled investment options across the US
- As the basis of debt funds are fixed-income investments, the risk involved is lower. Hence, more people like investing in debt funds than Liquid Funds.
- Debt funds incur lesser fees than Liquid Funds or any other equity traded funds, for that matter.
- If you wish to invest in debt funds, you can choose between passive and active funds. Both are equally lucrative.
Defining How Debt Funds Work
Your debt fund investments are split across several debt instruments, such as corporate or government bonds.
| Best corporate bonds to consider: IGIB: tracks investment outcomes from 5 to 10 years of data on the US corporate index. The asset diversification rate is 80%. USIG: Specialists in tracking the underlying index and splitting the funds across diverse options. SPIB ranks third in the list with net assets worth $8.37 billion and an expense ratio of 0.04. |
| Best government bonds to consider: SPTL: the most popular long government bond, with traction to the price and yield performance, as posted by Bloomberg record of the US Treasury. Net assets crossed $ 10 billion. GOVZ: the second-best long government bond in the US market, which tallies with the US treasury principal STRIPS index. However, the expense ratio is 0.15 SCHQ is another popular government bond that closely aligns with the Bloomberg US Treasury Index. |
Debt funds are invested in this fund but offer moderate prices. However, the operating margin of the funds is much higher.
The NAV of each fund depends on the funds’ purchasing and selling price points.
NAV grows when selling prices are higher and vice versa.
Bonds invest funds in several debt instruments and generate recurring interest. The interest you receive as fund holders bank FDs regarding return values.
There are more factors influencing the NAV of the debt funds. For example, the interest offered by individual underlying assets also alters the net NAV.
Let me explain the phenomenon with an example. Let’s say the market interest rates go down suddenly. As a result, the bond price also changes. The prices of the new bonds are mainly affected.
How Will it Affect You?
Let me use the same example to elaborate.
Assume your fund distributed your investment into an instrument offering an 8% interest rate.
And then the market dips. As a result, your investment may attract 6% interest instead of 8% in the end.
Accordingly, your 8% bonds also try to level the returns you’d expect from a lower interest rate bond.
After that, when the bond price hikes, the NAV of the concerned fund is boosted, too.
How do debt funds work differently from Liquid Funds?
The only stark similarity between debt and Liquid funds is that both are mutual funds. However, the Liquid Funds are not flexible. They are short-term investment funds. The average investment tenure runs upto 91 days.
Wait. There is another match, too.
The Liquid Funds are also safe like the dent funds. However, sources say that debt funds are safer.
Liquid funds invest your money into palpable instruments like:
- Treasury Bills
- Deposit certificates
- Commercial funds and other such funds
As they are also mutual fund clusters, we may define them as various debt funds.
The best Liquid Funds in the US market are:
- BLF FedFund, with a constant NAV and net assets of 149,899,847,226
- BLF’s Treasury Trust Fund, with a continuous NAV and net assets of
| 121,552,304,167 Circle Reserve Fund, with a constant NAV and net assets of 29588521733 |
Risks of Debt Funds
Debt funds deal with several security instruments. Each instrument deals with a separate risk level. However, the government’s debt fund has the least risk of all.
You can easily calculate the profile of an instrument from the company’s credit rating. This applies to corporate debt funds.
So, risk aversion is possible.
Most US companies issue investment-grade debt instruments. However, all such companies have stable finance and outstanding credit quality.
Your funds may also go into high-yield debt funds.
These funds pose a slightly greater risk. The companies issuing these funds have low-quality credit. However, it is not unsafe to invest in these funds. The main reason is that the firms with low credit quality are emerging brands.
Hence, they can offer better returns in the due course. However, there is a higher prospective risk, too.
Kinds of Debt Funds You May Invest In
We have discussed the instruments comprising debt finds so far. Now, let’s focus on the types of debt funds. As these are multi-cap funds, there are several options for diversifying instruments.
We know Liquid Funds are a type of debt fund. What are the other funds?
Overnight Funds
These funds have a maturity period of 1 day or 24 hours. However, you won’t expect high yields from these funds. However, these funds are mainly for liquidity and convenience.
Investors looking for counters to park funds quickly may invest here.
Liquid Funds
We already talked about Liquid Funds. These funds have an average maturity period of 91 days (3 months on average). However, Liquid Funds are steadier than the Overnight Funds. Their NAV volatility is much lesser.
Ultra-Short-Term Funds
If your investment arc is three months, you may invest in Ultra-short-term funds, too. But why prefer Ultra-short-term funds to Liquid Funds?
The main reason is that Ultra-short-term funds offer higher yields. At the same time, short-term funds incur lesser risk. So, they are the safest option, discussed till now.
Low Duration Funds
If you wish to take on risk, here’s your opportunity. The risk may be moderate, but the returns compensate for that.
As the investment tenure is higher (6 months minimum), there is a greater chance that the incumbent risks will be alleviated.
Money Market Funds
These are moderately stable funds with a maturity period of about one year. With a longer tenure, the type of investment is also different from money market funds.
They source revenue from interest earned. The higher duration manifests chances of capital gain as well.
Medium to Long-Duration Funds
- Medium-term duration- 3 to 4 years
- Longer term duration- 7 years or more
These funds invest in government bonds, private and public sector bonds, etc. All of these sources offer stable and generous interests. However, the funds may slump when market rates rise.
Credit Risk Funds
These funds invest your money into corporate bonds mainly. Around 65% of the public investments go there. However, not all corporate funds are credit-risk funds. The bonds that are rated AA or above count only.
Why do We Invest in Debt Funds?
Investing in debt funds is better for several reasons: you can redeem the funds quickly.
the redemption request moves faster to allow reinvestments to flow in.
There are no lock-in options, as banks or recurring deposits are offered. Hence, there is flexibility all around.
Some funds impose exit penalties when the exit load is higher. However, mutual funds do not incur such penalties. Hence making your payments more risk-free.
The Bottom Line
Liquid Funds are a great investment option. However, it would help if you tried the other debt fund options. Each fund offers a separate advantage. Hence, a credit mix with versatile investments will be better for your investment profile. To know more about this phenomenon, read the article on Credit Mix: Why is it Important?
If you need further advice on debt and Liquid funds, comment below!
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