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
