Types of Debt Funds

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  • 02 Oct 2023

Liquid funds are the most conservative alternative for investors looking for high liquidity and low risk among the various forms of debt funds. These funds are an important complement to any investing plan because they give investors a unique opportunity to produce steady returns while managing risk.

Key Highlights

  • Debt mutual funds provide an alternative investment option managed by experienced fund managers
  • Debt mutual funds come in various types catering to different investment goals and risk appetites.
  • Short, medium, and long-duration funds offer different income potential and interest rate sensitivity based on your investment horizon.

Debt funds provide a different investment option from traditional fixed-income securities like treasury bonds and bank fixed deposits. They are under the supervision of experienced fund managers who, working on the benefits of the investors, make investment decisions after taking into account various factors such as variations in interest rates, creditworthiness and market conditions. Debt mutual funds provide investors with a range of choices, each one suited to a different set of financial goals and different levels of risk tolerance. To fully understand the meaning of debt funds, consider their role in providing stability during market fluctuations.

There are various types of mutual funds available in the market, catering to different investment objectives and risk appetites. Investors often seek to understand the meaning of debt funds before investing in one. Knowing what is a debt fund can help you make informed investment decisions.

1. Liquid Funds

For investors seeking high liquidity and low risk, liquid funds are the most risk-averse among debt mutual funds.These funds mainly invest in debt securities with short maturities, frequently up to 91 days. Among the essential characteristics of liquid funds are Investors can access their units right away at any time, and often, their accounts are credited with the funds within one business day. Liquid funds are known for their stability and minimal risk due to their short duration and high-quality holdings. Liquid funds are known for their stability and minimal risk due to their short-term nature and high-quality securities.

2. Ultra Short Duration Funds

Ultra short duration funds always aim to provide liquidity and little volatility, although being a little more aggressive than liquid funds. These funds often invest in debt instruments with maturities between three and six months, which are a little bit longer. Due to their longer duration, ultra short duration funds carry a somewhat higher level of risk than liquid funds, albeit having slightly higher returns. Investors can fairly easily redeem their units, however it might take a day or two for the money to show up in their accounts due to liquidity. These funds aim to provide slightly better returns than liquid funds, making them suitable for investors with a slightly higher risk appetite.

3. Short Duration Funds

Investors often seek professional guidance to identify the best mutual funds for their specific financial goals and risk tolerance. Short duration funds have a moderate risk profile and aim to offer higher returns compared to liquid and ultra short duration funds. Short duration funds have the potential to provide better returns than ultra short duration and liquid funds, making them suitable for investors willing to take on a bit more risk. These debt mutual funds may be affected by changes in interest rates, which can lead to fluctuations in NAV. Investors should have a medium-term investment horizon when considering short duration funds.

4. Medium Duration Funds

Medium duration debt mutual funds offer a balanced mix of risk and return and are suitable for investors with a slightly longer investment horizon. These funds invest in debt securities with maturities ranging from 3 years to 4 years. Key features of medium duration funds include. Medium duration funds have the potential to provide higher returns compared to shorter-duration debt mutual funds. They are moderately sensitive to changes in interest rates, which can affect NAV. Investors should have a medium-term investment horizon, typically 3-4 years, when considering medium duration debt mutual funds.

5. Long Duration Fund

Investors often consult financial experts to identify the best mutual funds to invest in, seeking optimal returns for their portfolios. Long duration funds are at the higher end of the risk-return spectrum among debt funds. They invest in debt securities with longer maturities, often exceeding 5 years.

6. Credit Risk Funds

Credit Risk Funds invest in debt securities issued by lower-rated or riskier entities. While they offer the potential for higher returns, they also come with increased credit risk. Investors willing to take on more risk for the prospect of higher yields may consider these funds. It's important to note that credit risk funds require careful scrutiny of the fund manager's credit analysis capabilities.

7. Corporate Bond Funds

Corporate Bond Funds primarily invest in debt securities issued by corporations. They vary in risk levels based on the creditworthiness of the issuing companies. These funds offer potentially better returns than government bond funds but also come with credit risk. Corporate bond funds are suitable for investors looking to balance risk and return in their fixed-income portfolio.

8. Dynamic Bond Funds

Dynamic Bond Funds are actively managed funds that adjust their portfolio duration based on interest rate expectations. Fund managers make dynamic decisions to capture potential gains from changing interest rates. These funds offer a balance between income generation and capital appreciation potential. They are suitable for investors who want professional management of their fixed-income investments.

9. Income Funds

Income Funds aim to provide stable income through investments in a diversified portfolio of debt instruments. They are suitable for investors seeking regular income while minimising the impact of interest rate fluctuations. These funds can have varying maturities in their portfolio, making them versatile for different income needs.

Below table provides an overview of the risk levels associated with various types of debt funds. Risk levels can vary depending on the specific fund and market conditions.

Liquid Funds


Ultra Short Duration Funds


Short Duration Funds


Medium Duration Funds


Long Duration Funds


Credit Risk Funds


Corporate Bond Funds


Dynamic Bond Funds


Income Funds


Type Of Debt Funds Risk Level
Liquid FundsLow
Ultra Short Duration FundsLow-Moderate
Short Duration FundsModerate
Medium Duration FundsModerate
Long Duration FundsHigh
Credit Risk FundsHigh
Corporate Bond FundsVaries
Dynamic Bond FundsVaries
Income FundsVaries

1. Potential for High Returns

Long duration funds have the potential to provide higher returns compared to short and medium duration funds.

2. High Interest Rate Sensitivity

They are highly sensitive to changes in interest rates, which can lead to significant fluctuations in NAV.

3. Long Investment Horizon

Investors should have a long-term investment horizon, typically 5 years or more, when considering long duration funds.


Before making any investment decisions, it's essential to research and understand the various mutual fund types available to determine the most suitable options for your portfolio. Investors wishing to build a well-rounded investing portfolio in India have to understand the wide range of debt funds available. Debt funds provide a range of options, each catered to particular financial goals and risk tolerances. There is a debt fund that fits your objectives, whether you're a risk-averse person looking for stability, a moderate risk taker seeking balanced returns, or an aggressive investor seeking possible yield augmentation.

The most significant point to be learned from this investigation of debt funds is how crucial it is to match the correct debt fund for your investment horizon and risk tolerance. Understanding what is a debt fund is crucial for investors looking to diversify their portfolios and manage risk effectively in the stock market. Short, medium-duration and long-duration funds offer varying degrees of income potential and interest rate sensitivity to investors with longer time horizons.

FAQs On Types Of Debt Funds

Debt funds carry credit risk, interest rate risk, and liquidity risk. Credit risk is the risk of bond issuers defaulting on payments

Debt funds held for less than three years are subject to short-term capital gains tax, which is added to your income and taxed at your applicable income tax rate.

There are various types of debt funds, including liquid funds, short-term funds, income funds, and gilt funds.

Debt funds focus on fixed-income securities, providing more stable returns and lower risk compared to equity funds, which invest in stocks.

Returns from debt funds primarily come from interest income earned on the underlying bonds and securities in the fund's portfolio.

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