List of the top-performing debt mutual funds sorted by returns with their AUM and Expense Ratio.
Debt mutual funds are a type of mutual fund that pools money from investors to invest in fixed-income securities like corporate bonds, treasury bills, and government bonds. These securities are essentially loans given to companies or the government, where they promise to pay a fixed interest over time. Corporate bonds are issued by companies, while treasury bills and government bonds are issued by the government.
Debt funds invest in these securities and earn interest as returns. The interest paid by the companies or the government flows back to the fund and is distributed among investors. This distribution happens in proportion to the amount each investor has contributed. The returns are reflected in the fund’s Net Asset Value (NAV), which changes daily based on the performance of the securities. If the fund performs well, the NAV increases, and so does the value of your investment.
Like with any other debt, these funds carry certain risks. Here are the risks involved:
Interest rate risk is the risk that returns on fixed-income securities will be affected when there is a change in interest rates. In simple words, market interest rates do not remain constant; they change based on economic conditions. Bonds and market interest rates have an inverse relationship. When interest rates rise, new bonds are issued at higher coupon rates, which makes existing bonds less attractive, resulting in a decline in their market value or the NAV of a debt mutual fund. Alternatively, when interest rates fall, existing bonds with higher coupon rates become more desirable, moving their market value up.
Credit risk is the risk of default by the borrower. Say a company issued a bond but eventually failed to generate enough revenue to repay the principal amount. When an entity issues a bond, credit rating agencies like CRISIL assess its creditworthiness. They’re rated from AAA to BBB based on how credible they are and the possibility of default. Since debt mutual funds invest in multiple bonds, if any borrower defaults, it will bring down the value of the fund.
As the name suggests, liquidity risk arises when a debt mutual fund cannot easily sell its underlying securities. This happens when these funds invest in bonds, commercial papers, and treasury bills that are not frequently traded in the market. In this case, the fund manager will be forced to liquidate the bond holdings at a discounted price, potentially lowering the Net Asset Value of the fund and in turn impacting the returns of the investors.
To decide whether you should invest in a debt mutual fund or not, you must measure the good and the bad of each mutual fund category. For debt mutual funds, we know the following risks that are associated with them:
Let’s also consider, the good side of debt mutual funds:
1. Debt funds tend to offer more stable returns than equity mutual funds. In the case of equity funds, the underlying assets are stocks that are traded in the market. In the case of debt mutual funds, your investments are at lower risk. This is because in case the company fails to perform, debt holders are paid back before equity holders.
2. Debt mutual funds are popular for their high liquidity profile. This means that investors can withdraw funds whenever they wish and have the amount credited to their bank account within 2 to 3 days. However, in the case of other fixed-income securities like fixed deposits, there’s usually a lock-in period and heavy withdrawal charges are levied in case of early redemption.
Even the safest investments have some risk in them, which is why it is important to analyse key metrics before you decide which debt mutual fund is right for you:
1. Average Maturity: Look at the average maturity date of a fund. You can find this information easily on the funds' fact sheet. The average maturity is the average time it will take for all bonds in a debt mutual fund to mature. If an instrument matures early it allows the fund manager to reinvest that fund, maintaining liquidity of the fund. You can also compare the average maturity of a fund to that of its category average.
For example, in the case of a long-duration debt fund, if the average maturity period is 2.5 years, the fund is exposed to both credit risk, and interest risk. In the case of liquid funds, the average maturity period is 91 days hence interest rate risk is extremely low.
2. Yield to Maturity (YTM): Look at the Yield to Maturity. This metric tells you what the total return on this instrument would be if it’s held till maturity and if the interests are reinvested into the security. Generally, the higher the YTM, the better it is. For example, if fund A has a YTM of 7% and fund B has a YTM of 6%, it indicates that fund A is a better option.
3. Funds Allocation: Apart from metrics, you also need to get an overview of the allocation of funds. So, if a liquid fund has allocation well diversified in corporate and government bonds, it's a good sign. However, it is heavily invested in corporate papers, especially for a shorter-duration fund; it is taking on too much credit risk. You also need to look at the credit rating check that the fund has taken.
4. Compare with category average: You must also measure how each fund measures compared to its category average or peers. Check how many securities the fund owns compared to its peers. What does the average maturity and Yield to Maturity look like?
Yes, you can SIP in debt mutual funds. You can set up a daily, weekly or monthly SIP.
Debt mutual funds invest in bonds issued by corporates, governments, PSUs and banks. These funds then receive interest at a fixed rate at regular intervals. They also invest in treasury bills, Commercial Papers, Certificate of Deposits, etc. These securities are comparatively short-term in nature.
Debt funds invest in fixed-income instruments like government securities, corporate bonds, treasury bills and money market instruments. They tend to have lower volatility than equity funds, but they carry specific risks such as interest rate risk, credit risk and liquidity risk. So while debt funds are “safer” relative to equities, they are not without risk.
Yes, debt funds can offer monthly income, but it isn’t guaranteed. Many investors use Systematic Withdrawal Plans (SWP) to receive a fixed monthly payout from their debt fund investments. The actual returns depend on market conditions, so the monthly amount may vary slightly over time.
Debt mutual funds are usually considered a safer choice compared to equity mutual funds. However, they still hold certain risks like default risk, credit risk and interest rate risk. Investors should consider the potential impact of these risks before making an investment decision.
Credit agencies rate securities on the basis of their creditworthiness; this could be anywhere between AAA to BBB signifying how credible a security is in repaying the debt. Every debt mutual fund will include the credit rating of the security they have invested in. This helps measure the risk from a fund. If the fund invests in securities that have a low rating they may be taking on too much risk.
Debt mutual funds invest in securities that have a fixed coupon rate. However, market interest rates fluctuate based on economic conditions. These interest rates and debt funds have an inverse relationship. If the interest rate rises, the value of your debt fund will decrease. This happens because new bonds with higher interest rates will surface and existing bonds will seem less attractive. Similarly, if interest rates decrease, bonds with higher coupon rates become more attractive. Hence increasing the value of these debt mutual funds.
Debt fund expense ratios are lower because managing bonds is generally simpler and less research-intensive than managing equities. Debt portfolios involve fewer trading costs and lower risk analysis requirements, which allows fund houses to operate them at a lower overall cost.
The ideal portion of your portfolio to put in debt funds depends on your age, risk appetite, and financial goals. A general rule of thumb many investors use is to keep your age as the percentage in debt (for example, a 30-year-old may keep around 30 percent in debt). If you prefer lower risk or want stable returns, you can allocate a higher share to debt funds.
You should stay invested in a debt fund based on its maturity profile and your goal. For short-term needs, liquid and ultra-short funds work well for a few months to a year, while long-duration or gilt funds are better suited for goals three years or more. In general, match your investment horizon with the fund’s risk and duration for a smoother experience.
Yes, certain debt funds are suitable for short-term parking, especially liquid funds and ultra-short duration funds. They offer better liquidity, usually lower risk, and may provide slightly higher returns than a traditional FD. However, returns are not guaranteed, so they work best for goals where you want flexibility along with relatively low risk.
Debt funds carry a few unique risks investors should know about. The biggest ones are interest rate risk, where bond prices fall if interest rates rise, and credit risk, where a bond issuer may delay or default on payments.