Debt mutual funds explained: types, risks and returns
Written and reviewed by Omm · Last reviewed · General information, not investment advice
A debt fund lends money, mostly by buying bonds and money-market instruments issued by governments, banks, public sector companies and corporations. Returns come from interest and from price changes in those bonds.
The risks
- Interest-rate risk. When interest rates rise, the price of existing bonds falls, and so does a bond fund’s NAV. The longer a fund’s bonds last (its duration), the bigger the effect.
- Credit risk. The borrower may delay or fail to repay. Funds holding lower-rated bonds earn more interest to compensate for this risk.
- Liquidity risk. In stress, some bonds are hard to sell quickly, which can force a fund to sell at a discount or limit redemptions.
Debt funds are not fixed deposits. Their returns are not guaranteed, and the value can fall.
Common categories
| Category | What it does | Typical risk |
|---|---|---|
| Overnight | Lends for 1 day at a time | Lowest |
| Liquid | Instruments up to 91 days | Very low |
| Ultra short / low duration | Roughly 3 to 12 months | Low |
| Money market | Instruments up to 1 year | Low |
| Short / medium duration | Roughly 1 to 4 years | Moderate |
| Long duration / gilt | Many years, mostly government bonds | Higher interest-rate risk |
| Corporate bond | Mostly high-rated company bonds | Moderate |
| Credit risk | Lower-rated bonds for higher yield | Highest credit risk |
Match the fund’s duration to when you need the money. A fund whose bonds last far longer than your holding period can lose value in the meantime.
How to compare them
- Look at returns over several periods, not just the latest one. Short-term debt fund returns move with interest rates.
- Check the volatility and maximum drawdown on each fund page; in debt funds, a large drawdown is a warning sign of credit or duration risk.
- Compare within the category only.
- Read the riskometer and the portfolio in the fund’s monthly disclosure for credit quality.
Tax
Gains on most debt funds bought after 1 April 2023 are added to your income and taxed at your slab rate. See mutual fund taxation.
Liquid and overnight funds on this site
Their daily NAV changes are tiny, so one-year returns look like a fixed deposit rate. Some of these funds have also changed the face value of their units, which would look like a large fall in NAV. The site detects and adjusts for such changes so returns are not distorted.