What Is a Fixed Income Mutual Fund?

Fixed income mutual fund is a type of mutual fund that invests in fixed income securities such as government bonds, corporate bonds, money market instruments, certificates of deposit (CDs), etc. The aim of these funds is to provide periodic income to the investors in the form of dividends and capital appreciation. They are not very volatile in nature and are relatively safer investment avenues.

In India, fixed income mutual funds are regulated by the Securities and Exchange Board of India (SEBI). They invest in debt and money market instruments of various maturities and credit ratings.

Types of Fixed Income Mutual Funds

Based on the maturity period and credit risk of instruments they invest in, fixed income mutual funds in India can be classified into several categories. A few of them are:

Liquid Funds

Liquid funds invest in money market and short-term debt instruments, focusing on safety and liquidity. According to the Securities and Exchange Board of India (SEBI) regulations, the investments made by liquid funds must have a Macaulay duration of up to 91 days. The portfolio maturity is kept below 91 days. Their objective is to deliver reasonable returns to investors with low risk and high liquidity. They are ideal for parking short term surplus funds.

Ultra Short Duration Funds

Ultra short duration funds invest in money market instruments and short-term debt securities, while maintaining the Macaulay duration of their portfolio between 3 to 6 months, as per SEBI guidelines. This means the average time to receive the fund’s cash flows is very short, making these funds less sensitive to interest rate changes compared to longer-duration debt funds.

Low Duration Funds

Low duration funds invest in money market instruments and short-term debt securities, maintaining a Macaulay duration between 6 and 12 months as per SEBI regulations. This means that these funds are less sensitive to interest rate changes than longer-duration funds, but slightly more sensitive than liquid or ultra short duration funds.

Money Market Funds

Money market mutual funds invest in money market instruments that mature within one year. Their portfolios include commercial paper, certificates of deposit, treasury bills and repo agreements. They aim to give returns similar to short term bank deposit rates with high liquidity. These funds have low credit and interest rate risks. They are suitable for parking funds for very short durations.

Short Duration Funds

Short duration funds invest in debt and money market instruments such that the Macaulay duration of the portfolio is between 1-3 years. By managing the portfolio duration, they aim to provide stable returns with lower volatility compared to medium and long duration funds. A major portion of the fund corpus is invested in highly rated corporate bonds and PSU bonds. They carry moderately low credit risk and interest rate risk. Short duration funds are ideal for investors with investment horizon of 1-3 years.

Corporate Bond Funds

Corporate bond funds predominantly invest in highest rated corporate bonds and debentures. The aim is to generate income through exposure to high quality corporate debt. The maturity period of instruments can range from short to long term. The funds allocate majority of assets to AA+ and above rated corporate bonds. The returns tend to be higher than gilt funds with moderately higher credit risk. Corporate bond funds are ideal for risk averse investors looking for higher yields from highest rated corporate debt.

Credit Risk Funds

Credit risk funds invest minimum 65% of their assets in AA and below rated corporate bonds, except below BBB rated bonds. The remaining is allocated to highest rated CDs and money market instruments. The objective is to generate higher returns by taking moderately higher credit risk. These funds carry higher risk compared to corporate bond funds. The returns are higher to compensate for the additional risk taken. Credit risk funds are ideal for informed investors willing to take higher credit risk in exchange for higher returns.

Banking and PSU Funds

Banking and PSU funds invest at least 80% of their portfolio in debt instruments issued by banks, Public Sector Undertakings (PSUs), public financial institutions, and municipal bonds. These funds primarily hold high-credit-quality securities such as bonds, debentures, and certificates of deposit issued by government-backed or government-owned entities, making them relatively low risk compared to other corporate bond funds.

Advantages of Fixed Income Mutual Funds

• Provide diversification to the portfolio
• Offer stability and steady income through dividends
• Manage interest rate risk efficiently
• Lower risk compared to equity funds
• Provide easy liquidity
• Professionally managed by experienced fund managers
• Help park short term surplus funds
• Option to invest in high grade corporate bonds
• Convenience of paperless online investing

How Do Fixed Income Mutual Funds Work?

Fixed income mutual funds work by pooling money from thousands of investors and investing in various debt securities. Units are issued by the fund based on the amount invested. A fund manager handles the investments adhering to the objectives of the scheme. Based on the profitability of investments, dividend payouts are made periodically to unit holders. The units can be redeemed by investors anytime at the prevailing Net Asset Value (NAV). Capital gains taxes need to be paid by investors on redemptions.

How To Evaluate Fixed Income Mutual Funds ?

When selecting fixed income mutual funds to invest, here are some parameters that can be evaluated:

• The fund category and investment objectives
• The types of debt securities in the portfolio
• The fund's average maturity period
• The portfolio credit quality
• The size of assets under management
• The expense ratio and exit load
• The fund manager's experience and track record
• The historical returns given by the fund
• The volatility levels of the fund
• The fund house's overall reputation and services

By evaluating these factors, investors can shortlist funds that match their investment goals and risk appetite. Reading scheme documents and financial reports also helps in making informed decisions.

Conclusion

Fixed income funds help investors achieve constant and low volatile returns and reduce risks. By knowing the types, risks, tax implications and advantages, investors can make a well-informed decision to invest their hard-earned money in these funds. Taking the advice of a financial advisor also helps in choosing funds that suit certain financial objectives and periods. Fixed income mutual funds provide a less risky, tax-advantaged way to generate stable monthly income or create long term wealth.