Debt Mutual Funds

Prelims: Indian Economy| Current events of national and international importance

Why in news?

RBI has recently started a rate-cutting cycle and FD rates declining, which makes investors shifting to debt funds.

• Debt Mutual Funds – Investment funds that pool money to buy fixed-income securities like government bonds, corporate bonds, treasury bills, etc.
• Regulated by – Securities and Exchange Board of India (SEBI).
• Lower risk – It generates steady returns with lower risk compared to equities.
• It is popular among risk-averse investors and those looking for diversification.
• Categories of Debt Funds as per SEBI,
  • Liquid Funds
  • Ultra-Short Duration Funds
  • Short Duration Funds
  • Gilt Funds
  • Dynamic Bond Funds
  • Credit Risk Funds

Significance of Debt Mutual Funds

• Stable returns – It offers more predictable and stable returns compared to equity funds.
• Diversification for investors – They provide an opportunity to diversify portfolios, balancing risk especially for conservative investors or those nearing financial goals.
• Better tax efficiency – Debt funds that held for more than 3 years can enjoy indexation benefits, reducing the tax liability compared to fixed deposits.
• Liquidity – Most debt mutual funds offer higher liquidity than traditional fixed deposits, allowing investors to redeem investments partially or fully.
• Relationship with interest rates – The debt fund performance is closely tied to the Monetary Policy stance of the RBI's Monetary Policy Committee (MPC) and is in inverse relationship with interest rates that means,
• When interest rates fall, bond prices rise and Debt fund returns increase.
• When interest rates rise, bond prices fall and Debt fund returns decline.
• Reason – Existing bonds offer higher fixed returns than newly issued bonds during falling interest rates, making them more attractive.
• During rising interest rates, new bonds offer better yields, reducing demand and price for existing bonds.

Reference

The Hindu| Debt Mutual Funds