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Fixed Income Funds

Fixed Income Funds

Fixed Income or Debt Funds endeavor to provide potential for stable and regular returns. They are best suited for investors with a short to medium term investment horizon.

What are Fixed Income Funds?

A debt mutual fund scheme invests a significant portion of its portfolio in fixed-income securities like government securities (G-Sec), debentures, corporate bonds and other money-market instruments. By investing money in such avenues, debt funds aims to lower the risk factor in your investments. Different investors have different investment needs depending on their financial situations, risk appetite and investment objectives. These funds offer different category of funds for a wide range of investment needs.Debt Funds is a relatively stable investment avenue that could help to generate wealth. Mutual Fund Debt Funds are also known as fixed income mutual funds.

Features & Benefits

  • Fixed income mutual funds aim to generate returns by investing in bonds and other fixed-income securities which means that these funds buy the bonds and earn interest income on the investments. The investment yield received by the investor is based on this. This is very similar to how a Fixed Deposit works. When you deposit money in a bank, you technically lend the money to the bank in return of which the bank offers you interest.
  • However, there are various nuances to fixed income funds. For example, a liquid fund can buy securities of maturity upto 91 days and a Gilt fund can invest only in government bonds. Also, fixed income MFs do not offer assured returns as the returns are market linked and can fluctuate.

  • Debt mutual funds can give higher returns
  • Debt mutual funds are fixed income mutual fund schemes which invest in debt and money market instruments like Commercial papers, debentures, T-Bills and government securities etc. These instruments pay interest during the investment tenure and pay the principal amount upon maturity. The yields of many of these instruments may be higher than bank FD interest rates with similar maturities. That is why the trailing returns of different debt fund categories are higher than that of bank interest / fixed deposits over different time horizons.

  • Debt Fund Category1 year return3 year return5 year return10 year return
    Liquid Funds5.68%6.42%6.73%7.45%
    Ultra-short Duration Funds6.52%6.43%7.06%7.94%
    Money Market Funds7.10%7.01%7.27%7.95%
    Short Duration Funds3.97%5.33%6.537.47%
    Corporate Bond Funds8.08%6.92%7.48%7.68%
    Dynamic Bond Funds8.85%6.32%7.15%8.09%
    Banking & PSU Debt Funds10.19%7.73%7.93%7.82%
    Gilt Funds14.74%8.25%8.61%8.76%
    Fixed deposits6.00%7.00%8.00%8.00%
    Source: Advisorkhoj Research

    Returns as on 30th April 2020 - Returns are average for each category, returns over 1 year periods are annualized.

    Past performance may or may not sustain in future. The returns provided above are for category of schemes and does not in any manner indicate performance of any individual scheme of the Mutual Fund.

    Variety of solutions for different investment needs

    While bank FDs offer fixed interest, they might be sub-optimal assets on a post-tax inflation adjusted basis. Debt fund investments on the other hand, offer solutions for different investment needs and tenures. For example - Overnight funds and Gilt funds have no credit risk. Other funds have varying interest rate and credit risks. You can invest according to your risk appetite. Similarly, there are different products categories for different investment tenures e.g. few days, few weeks, months or 1, 2, 3 years or even longer time periods.

    Tax efficiency

    In Fixed deposits, the interest earned is taxed annually on the income you are falling in irrespective of the FD maturity date which may or may not be in that year. In case of debt mutual funds, you pay tax only in the year in which you redeem your funds and not before that. Upon redemption, you pay Short Term Capital Gains (STCG) tax if the investments were held for less than 3 years and Long-Term Capital Gains (LTCG) if the same was held for more than 3 years. LTCG are eligible for indexation benefits due to which you are taxed only on the returns which are over and above the inflation rate. This helps reduce the tax outgo and may give superior post tax returns.

Debt Schemes / Fixed Income Schemes

  • Fixed income funds in India offers solution for a wide range of investment needs basis your risk taking appetite and tenure of investment. According to SEBI categorization, there are 16 categories of debt mutual funds. Here, we will discuss about some key debt fund categories.
  • Liquid Funds Liquid funds invest in debt and money market instruments like commercial papers, certificates of deposits, treasury bill etc. which mature within 91 days. High credit quality liquid funds have very low risk and are suitable for parking your surplus funds for a few weeks to few months. According to SEBI directive, these funds charge graded exit loads for withdrawals within 7 days from the date of investment.
  • Overnight Funds Since these debt funds invest in fixed income instruments which mature overnight, they have virtually no interest rate risk. Overnight instruments are backed by collateral which comprises of Government Securities; therefore, these are the safest amongst debt funds. The yield of Overnight Funds is usually also the lowest.
  • 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. In simplified terms, Macaulay Duration is the interest rate sensitivity of a fixed income instrument. These funds aim to hold the instruments in their portfolio till maturity and earn interest paid by them, aiming to give stable returns in different interest rate scenarios. Short duration funds are suitable if the investment tenure is 2 – 3 years.
  • Banking and PSU Debt Fund Banking and PSU Funds are fixed income funds which invest in debt and money market instruments issued by banks, PSUs and public financial institutions. As per SEBI’s mandate Banking and PSU Funds must invest at least 80% of their assets in instruments issued by such institutions. Debt and money market instruments issued by banks and PSUs are usually of superior credit quality and more liquid compared to instruments of other private sector issuers.
  • Dynamic Bond Funds Dynamic bond funds have the flexibility to invest across durations depending on their interest rate outlook. If the fund manager expects interest rates to fall, he / she will invest in longer duration instruments to benefit from price appreciation. Likewise, if the fund manager expects interest rates to rise, he / she will invest in shorter duration instruments to get higher yields and reduce interest rate risk. Investors who have appetite for short term volatility and a sufficiently long investment horizon (at least 3 years or longer) can invest in these funds.
  • Gilt Funds These funds invest at least 80% of the portfolio Government Securities; therefore, these funds have very low credit risk. However, these funds have high sensitivity to interest rate changes. They can give high returns when yields are falling but can be quite volatile in the short term if yields spike due to any reason. Investors should have high appetite for volatility and at least 3 years or longer investment tenures for investment in Gilt funds.

Why Invest in Fixed Income Funds?

  • Flexibility - Debt funds offer you the option of switching your investments to different funds. For example - through a Systematic Transfer Plan (STP), you have the option to invest a lump sum amount in a debt fund scheme, say liquid fund, and transfer a fixed amount in a fixed frequency into equity or other funds. This way you can spread out the risk of investment in equities over a time period rather than investing the entire amount at a time. Other traditional investment options, like Fixed deposits (FDs) do not offer this kind of flexibility to investors.
  • Potentially Stable income - Debt Funds have potential to offer capital appreciation over a period of time. Debt funds have accrual income from coupons (interest) paid by bonds and debentures in the scheme portfolio and also the possibility of price appreciation if the interest rates fall. Fixed income funds usually come with a lower degree of risk than equity funds.
  • Liquidity – Fixed income mutual funds have no lock-in periods. You can withdraw your money from the fund on any business day subject to exit load if any. Redemption amount is credited to your bank account on Transaction (T) + 3 days basis. In case of liquid, overnight and ultra-short duration funds, redemptions are credited basis T+1 day. On the other hand, fixed deposits come with a specified lock-in period and if you liquidate it prematurely, the lender may charge you a penalty.
  • Stability - Equity funds may give higher returns in the long run but they can be extremely volatile too as the returns are linked directly to stock market performance. By investing a port of your portfolio in debt mutual funds, you can diversify your portfolio and bring down overall risk of the portfolio.
  • Systematic investing – You can invest in an appropriate debt fund scheme to meet you long term investment goals through SIPs. Equity funds are more popular for investing through SIPs, but debt fund SIP can offer more predictable returns while aiming to provide stability to your investments.
  • Tax efficiency

    In bank FDs, interest whether paid out or accrued is taxable. The bank deducts 10% TDS on the interest (unless you submit Form 15G to the bank). The interest paid out or accrued is added to your income and taxed according to your income tax rate. In debt mutual funds, incidence of taxation arises only if you redeem your units. You pay Short Term Capital Gains (STCG) tax if you hold your investment for less than 3 years and Long-Term Capital Gains (LTCG) for investments held beyond 3 years. Long term capital gains made in fixed income funds held for more than 3 years are taxed at 20% after allowing for indexation benefits. Indexation benefits can reduce the tax obligations of investors in higher tax brackets substantially.


AMCs disclose the credit rating profile of all assets held in the fixed income fund in their monthly factsheets. You should refer to the monthly factsheet to understand the credit quality of the fund before making investment decisions. Monthly factsheets are available on the AMC websites.

The maturity of a fixed income instrument is the date on which the issuer repays the principal to the investor. The issuer also makes periodic interest payments (coupon) during the maturity term. The maturity of a debt fund is weighted average maturities of all the individual instruments held in the scheme’s portfolio.

As mentioned earlier investment tenure influences your risk capacity. You should try to match the duration profile of debt funds with your investment tenure. For very short investment tenures (few days / weeks / months), you should invest in overnight funds, liquid funds or ultra-short duration funds. For 1 – 3 year investment tenures, you can invest in short duration funds or funds whose duration profile is less than 3 years. If investment tenure is above 3 years, you can invest in dynamic bond funds, banking & PSU debt funds and Gilt funds.

It is right that corporates and institutions account for a very large percentage of debt fund AUM, but these funds also offer investment solutions to retail investors over traditional investment options for a variety of investment needs. Debt funds are ideal for portfolio diversification and meeting your short, medium and long term investment goals by taking relatively lower risk.

Yes, just like equity funds, you can invest in debt funds also through SIP route. Various debt funds categories aim to provide superior returns in the long run with relatively lesser risk and volatility compared to equity funds and thus may be helpful for meeting your financial goals.

YTM of a fixed income instrument is the yield (return on investment) if you buy the instrument at its current price and hold it till its maturity. When calculating yields, both interest payments and principal payment on maturity should be taken into consideration. Remember, YTM can change over time depending on interest rate movement. When interest rates rise, YTM will also rise and vice versa. YTM of a debt fund is weighted average YTMs of individual instruments in the scheme’s portfolio.

Modified Duration or simply duration is the interest rate sensitivity of a fixed income instrument. For example - if the duration of an instrument is 3 years, then for every 1% fall in interest rate, the price of the instrument will rise by 3% and vice versa. Duration is related to maturity i.e. longer the maturity, longer the duration.

Credit rating is a measure of the creditworthiness of the issuer to meet interest and principal payment obligation. Credit ratings are assigned by specified credit rating agencies like CRISIL, ICRA and CARE etc. Credit rating of an instrument may change over time, depending on change in the financial strength of the issuer. If the credit rating of an instrument gets downgraded, its price will fall and vice versa.

Government securities (G-Secs) are also known as Gilts. Like any other bond, Gilts also have fixed maturities, during which they pay interest and principal on maturity. Since they are issued by the Government, Gilts have no credit risk at all. However, long term Gilts have high interest rate sensitivity due to their long durations.

How Indexation is applied in debt fund taxation: By applying indexation, the investor is allowed to adjust the purchase price to reflect inflation for capital gains tax. For example - if you invested in a debt fund in FY 2016 at a NAV of Rs 100 and sold it in FY 2020 at a NAV of Rs 130, you will be allowed to adjust your purchase NAV by a factor of 1.137 (ratio of cost of inflation index in FY 2020 and FY 2016) and your adjusted purchase price will be Rs 113.7. Therefore, the tax will be applicable on gain of Rs 16.30 (Rs 130 – Rs 113.70) only. Long term capital gains (held for more than 3 years) in debt funds are taxed at 20% after indexation.

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