There are various types of schemes in the debt fund category, which are classified
on the basis of the type of instruments they invest in and the tenure of the instruments
in the portfolio, as explained below:
Liquid & Money Market FundsSavings bank deposits have been
the retail investors’ preferred investment option to park surplus cash. Most investors
regard these as the only avenue while some believe parking surplus cash elsewhere
can erode their capital and does not provide liquidity. CRISIL’s recent study draws
attention to a more attractive option – Liquid Fund / Money Market Mutual Funds.
The analysis underlines that surplus cash invested in money market mutual funds
earns high post-tax returns with a reasonable degree of safety of the principal
invested and liquidity.
Liquid Funds, as the name suggests, invest predominantly in highly liquid money
market instruments and debt securities very short tenure and hence provide high
liquidity. They invest in very short-term instruments such as Treasury Bills (T-bills),
Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending &
Borrowing Obligations (CBLO) that have residual maturities of up to 91 days to generate
optimal returns while maintaining safety and high liquidity. Redemption requests
in these funds are processed within one working (T+1) day.
Income fundsThey invest primarily in debt instruments of various
maturities in line with the objective of the funds and any remaining funds in short-term
instruments such as Money Market instruments. These funds generally invest in instruments
with medium- to long-term maturities.
Short-Term fundsShort-term debt funds primarily invest in
debt instruments with shorter maturity or duration. These primarily consist of debt
and money market instruments and government securities. The investment horizon of
these funds is longer than those of liquid funds, but shorter than those of medium-term
Floating Rate funds (FRF)While income funds invest in fixed
income debt instruments such as bonds, debentures and government securities, FRFs
are a variant of income funds with the primary aim of minimizing the volatility
of investment returns that is usually associated with an income fund. FRFs invest
primarily in instruments that offer floating interest rates. Floating rate securities
are generally linked to the Mumbai Inter-Bank Offer Rate (MIBOR), i.e., the benchmark
rate for debt instruments. The interest rate is reset periodically based on the
interest rate movement. The objective of FRFs is to offer steady returns to investors
in line with the prevailing market interest rates.
Gilt FundsThe word ‘Gilt’ implies Government securities. A
gilt fund invests in government securities of various tenures issued by central
and state governments. These funds generally do not have the risk of default, since
the issuer of the instruments is the government. Gilt funds invest in Gilts which
have both short-term and/or long-term maturities. Gilt funds have a high degree
of interest rate risk, depending on their maturity profile. The longer the maturity
profiles of the instruments, the higher the interest rate risk. (Interest rate risk
implies that there is an effect on the market price of debt instruments when interest
rates increase and decrease. Market prices of debt instruments rise when interest
rates fall and vice-versa.)
Interval FundsInterval fund is a mutual fund scheme that combines
the features of open-ended and closed-ended schemes, wherein the fund is open for
subscription and redemption only during specified transaction periods (STPs) at
pre-determined intervals. In other words, Interval funds allow redemption of Units
only during STPs. Thus between two STPs they are akin to closed-ended schemes and
therefore, compulsorily listed on Stock Exchanges. However, unlike typical closed-ended
funds, interval funds do not have a maturity date and hence open-ended in nature.
Hence, one may remain invested in an Interval Fund as long as one wishes to like
any open ended schemes. Hence, in a sense, interval funds are akin to Fixed Maturity
Plans (FMPs) with roll-over facility, as they allow roll over of investments from
one specified period to another.
Interval funds are typically debt oriented products, but may invest in equities
as well as per the scheme’s investment objective and asset allocation specified
in the Scheme Information Document.
Interval funds are taxed like any other mutual fund, depending on whether the underlying
portfolio is pre-dominantly invested in equities or debt securities. If the fund
invests 65% or more of its corpus in debt securities, it is taxed like a non-equity
fund. Likewise, if the fund invests 65% or more in equities, it is taxed like an
Multiple Yield FundsMultiple yield funds (MYFs) are hybrid
debt-oriented funds that invest predominantly in debt instruments and to some extent
in dividend-yielding equities
The debt instruments assist in generating returns with minimum risk and equities
assist in long-term capital appreciation. MYFs invest predominantly in debt and
money market instruments of short-to-medium-term residual maturities.
Dynamic Bond FundsDBFs invest in debt securities of different
maturity profiles. These funds are actively managed and the portfolio varies dynamically
according to the interest rate view of the fund managers. Such funds give the fund
manager the flexibility to invest in short- or longer-term instruments based on
his view on the interest rate movement. DBFs follow an active portfolio duration
management strategy by keeping a close watch on various domestic and global macro-economic
variables and interest rate outlook.
Fixed Maturity Plans (FMPs)FMPs, as the name indicates, have
a pre-determined maturity date (like a term deposit) and are close-ended debt mutual
fund schemes. FMPs invest in debt instruments with a specific date of maturity,
lesser than or equal to the maturity date of the scheme, also enjoy the status of
debt funds. After the date of maturity, the investment is redeemed at current NAV
and the maturity proceeds are paid back to the investors.
The tenure of an FMP may range from as low as 30 days to 60 months. Since the maturity
date and the amount are known beforehand, the fund manager can invest with reasonable
confidence, in securities that have a similar maturity as that of the scheme. Thus,
if the tenure of the scheme is one year then the fund manager would invest in debt
securities that mature just before a year. Unlike in other open ended funds, where
one can buy and sell units from the mutual funds on an ongoing basis), no pre-mature
redemptions are permitted in FMPs. Hence, the units of FMPs (being close ended schemes)
are compulsorily listed on a stock exchange/s so that the investors may sell the
units through stock exchange route in case of urgent liquidity needs.
Monthly Income Plans (MIPs)MIPs are hybrid schemes that invest
in a combination of debt and equity securities, but are typically debt oriented
mutual fund schemes, as they invest pre-dominantly in debt securities and a small
portion (15-25 per cent) in equities.
MIPs offer regular income in the form of periodic (monthly, quarterly, half-yearly)
dividend pay-outs. Hence MIPs are preferred option for investors seeking steady
income flows. Under MIPs, monthly income or regular dividend is neither assured
nor is it mandatory for mutual funds to pay at stated intervals, because in a mutual
fund scheme, the dividend is paid at the discretion of the mutual fund and is subject
to availability of distributable surplus from realised gains.
Due to the equity exposure, MIP returns can be volatile and may suffer losses, making
dividend pay-outs irregular - both in quantum and frequency or even skip dividend
payment. In spite of this, MIPs have a history of providing higher returns after
adjusting for tax and hence can be a better option.
Investors wary of fluctuating income from MIPs' dividend option can opt for Growth
Option and a systematic withdrawal plan, or SWP, which allows regular redemption
of a pre-determined amount. An SWP under an MIP can work as a regular source of
income for investors. SWP works better when a person invests a large sum.