Debt Funds

Mutual Fund Investment

Debt Funds

By Jupiter Team · · 5 min read

Debt is considered among the safest investment classes for anyone with excess cash. The debt market comprises several financial instruments that enable the borrowing and lending of funds for interest.

However, since debt is safer than other asset classes, it also offers lower returns. Nonetheless, it is an ideal investment option for risk-averse individuals.

What are debt funds?

Debt funds are a suitable investment for those with a low appetite for risk. Here, investors put money in securities that generate a fixed income. The interest rate and the maturity period are pre-decided by the issuer, thus the name ‘fixed-income securities’.
Examples of such funds are treasury bills, corporate bonds, commercial papers, and much more.

How do debt funds work?

Debt funds mostly work based on credit ratings. Fund managers use this factor to filter out a variety of low-quality debt securities. Higher-rated debt securities imply that the issuer is less likely to default.

However, this does not mean that low-quality ones are not worthwhile. A few fund managers, with a larger risk appetite, might account for the higher returns on low-quality debt instruments and invest in them.

The interest rates also influence the fund manager’s decision – they invest in long-term securities when interest rates are falling and short-term securities when interest rates are rising.

Who should invest in debt funds?

Debt funds are diversified across multiple securities, so returns are stable and within the expected range.

Therefore, these funds are ideal for those with a low-risk tolerance. However, they can also work for investors looking for a short-term or medium-term holding for excess cash.

Moreover, debt fund returns are better than bank deposit returns.

Types of debt funds

Debt funds can be categorised based on their maturity periods. They are as follows:

Liquid fund

It invests in securities that generally mature in 91 days and is an ideal short-term investment.

Dynamic bond fund

It is dynamic because it invests in securities with different maturity dates. It is meant for those with medium risk tolerance and an investment window of three to five years.

Money market fund

It invests in securities that mature within a year and is suitable for those looking for safe debt securities in the short term.

Gilt fund

It invests only in government-issued securities and carries a low credit risk. Thus, it is great for those with a low-risk appetite.

Banking and PSU fund

80% of the assets are invested in debt securities of public sector undertakings (PSUs) and banks and these are meant for risk-averse investors.

Corporate bond fund

80% percent of the assets in this fund are invested in corporate bonds. Such a fund is ideal for investors with low-risk tolerance and those who are interested in high-quality corporate bonds.

Floater fund

65% of its investible corpus goes into floating rate instruments. Such funds help mitigate the risk of market volatility.

There are several other types of debt funds like the overnight fund, ultra-short duration fund, low duration fund, medium duration fund, and much more.Moreover, their maturities range from one day to four years.

Things to remember before investing in debt funds

Risk factor

Although they are among the safest securities, they carry a credit risk (of the issuer defaulting) and interest rate risk (price drop due to an increase in interest rate).

No guaranteed returns

Debt fund returns are not guaranteed. Moreover, the Net Asset Value (NAV) of a debt fund can fall with an increase in interest rates.

Associated costs

There is an expense ratio included in the investment amount. The Securities and Exchange Board of India (SEBI) mandates that this percentage be 2.25% or less of the overall asset.

Varying investment horizons

If you want a short-term investment, you may choose to put money in liquid funds. However, if you have a longer horizon, then you may invest in dynamic bond funds and earn better returns.


Capital gains from both short-term debt funds and long-term debt funds are taxable.

How are debt funds taxed?

Before investing, it is important to understand the debt fund taxation. All the dividends received from these funds are taxed in a classical manner since Budget 2020. The tax rate depends on the holding period.

If it is shorter than three years, then the returns are called short-term capital gains (STCG) and are taxed as per the income tax slab of the investor.

On the other hand, long-term capital gains (LTCG) occur when the holding period is longer than three years and are taxed at 20% after indexation.  

How to invest in debt mutual funds?

Today, there are several third-party platforms online through which you can start to invest directly in debt mutual funds.

All you need to do is register, get your know-your-customer (KYC) in order, provide your investment details, and choose from the available options.  

Top 10 best debt mutual funds in India

Here are some of the best debt mutual funds in India.

HDFC Short Term Debt Fund

86% of the assets in this fund are in debt and of this, nearly 23% is in government securities while the remaining is invested in low-risk securities. This fund is the right choice for investors with a low-risk appetite who are planning to stay invested for a couple of years.

SBI Short Term Debt Fund

This one has a Credit Rating Information Services of India Limited (CRISIL) rank of three and 33.30% of its debt investment is in government securities. It is a good alternative for bank deposits, especially for a period of one to three years.

ICICI Prudential Equity and Debt Fund

Unlike a typical debt fund, this one has around 60-80% of its assets in equity and about 40-49% in debt. So, it is riskier than other debt funds but offers higher returns too. Risk-averse individuals who are looking for better returns on investment may consider this fund.

Axis Bank and PSU Debt Fund

This fund mainly invests in money market instruments issued by banks, public financial institutions, and PSUs. It is suitable for an investment horizon of two to three years and is a good alternative to bank deposits.

HDFC Banking and PSU Debt Fund

In addition to PSUs and public banks, this fund invests in instruments of Scheduled Commercial Banks (SCBs), Municipal Corporations, and similar bodies. Moreover, almost 60% of its portfolio is allocated to AAA credit-quality instruments.

SBI Magnum Ultra Short Duration Fund Direct - Growth

This fund has 96% invested in debt issued mainly by finance sector companies. It is suitable for an investment horizon of three to five years and offers some of the highest returns in that duration. Moreover, the good credit rating of the fund also indicates that the risk of default is lower.

Edelweiss Government Securities Fund Direct - Growth

This is a type of gilt fund because it only invests in government securities. As a result, the credit risk is low, and it is suitable for risk-averse investors.

Kotak Dynamic Bond Fund

It invests largely in government securities of varying maturities and is great for an investment horizon of three to five years.

ICICI Prudential All Seasons Bond Fund Direct Plan - Growth

It invests in a variety of debt and money market instruments and has a combined goal of providing returns while ensuring safety and liquidity. It is suitable for those with a moderate-level risk appetite.

SBI Magnum Income Direct Plan - Growth

Rated as a fund with moderately high risk, this one is suitable for investors looking to earn regular income through investment in debt and money market instruments.

Frequently Asked Questions (FAQs)

Are there any risk-free debt funds?

Liquid funds and overnight funds are examples of debt funds with nearly zero risk. However, most others do carry an element of risk. So, it is advisable to conduct extensive research before investing.

Which type of debt fund is the best?

That depends on the investment horizon. You may look for funds that lend to high-quality borrowers and pick a good fund in the desired category.

Is there a lock-in period with debt funds?

No, there is no lock-in period. These funds not only offer better post-tax returns than FDs but also avoid locking your money.

Are debt funds a good investment?

Yes, these are a great choice for those who want to fulfil short-term goals, earn better returns than FDs, and keep the capital intact.

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