Debt mutual funds are not a loved lot. Equity diversified mutual funds on the other hand have caught on the fancy of investors more because they invest in stocks. Stocks means making lots of money overnight to a lot of people. However, very few can ever do that. So when it comes to debt funds, investors aren’t an enthused lot. However, we must know where do debt mutual funds invest because debt mutual funds serve as a very important mechanism to balance your asset allocation.
Here is a small primer on what debt funds are where do debt mutual funds invest
What are debt mutual funds ?
Debt mutual funds are mutual funds that invest primarily in fixed income instruments. Their main aim is to preserve capital and earn decent returns – a bit more than what savings accounts and bank fixed deposits earn. So they are a combination of capital preservation and regular income.
Prices of debt mutual funds and interest rates are inversely related.
Where do debt mutual funds invest ?
Depending on the tenure of the underlying asset, one could classify a debt mutual fund as a short term, medium term or long term debt mutual fund.
Less than one year
Commercial Papers: They are short-term papers issued by companies to cover their short-term borrowing requirements. The risk is quite low due to a lower tenure. It is a lower cost alternative to borrowing from a bank. CPs can be issued for maturities ranging from 15 days to 1 year. Short-term debt funds invest in these papers.
Certificates of deposits: It is the same as a commercial paper, except that these are issued by banks. Usually, short-term funds or FMPs (Fixed Maturity Plans) invest in these papers. Their tenure ranges from 1 month to 5 years.
Collateralised borrowing and lending obligation (CBLO): This is basically an overnight window, which is offered by the Clearing Corporation of India. Funds invest here only for a day or two. This facility is used by liquid funds.
Treasury Bills (T-Bills): They are issued by the Government of India to raise money from the public and usually have tenures of 90, 182 and 364 days. They are extremely safe as they carry a sovereign guarantee. Again, short-term debt funds invest in these securities.
One year and above
Corporate Bonds: These are bonds issued by PSUs and are rated by credit rating agencies. Medium-term and long-term debt funds usually invest in them.
Debentures: Issued by Indian companies, these bonds are also rated and medium and long-term bond funds invest in them as in accordance with their investment mandates.
In India, the word bonds and debentures are often used interchangeably. Bonds are secured against some assets while debentures are not. Bonds are generally referred to debt instruments issued by financial instruments and the government while debentures refer to corporate debt.
Securitized paper (Pass through certificates): These are papers issued by banks securitising a loan that they have offered to a single corporate entity. Through PTCs, banks transfer some of their risks and assets to other investors like NBFCs and mutual funds. Long and medium-term bond funds invest in these certificates.
Government bonds (Gilts): These are bonds issued by the government of India and carry sovereign guarantee; hence, they are highly safe. There are special gilt funds that invest in the government bonds.
We will learn about where do debt mutual funds invest and we’ll learn about the different types of debt funds in a future article.
It was recently said that IT dept must be informed of investments made over 2 lakhs in Mutual funds & the same has to be mentioned in the IR return.Does this 2 lakh limit apply for investment in 1 fund or the collective investment across all mutual funds in a fin.year?
@Muthu, I think it is cumulative across all MFs.
The Biggest problem with Debt Mutual Funds is the Long Term Capital Gains from such funds are taxable. Dividends received are exempt, though.
But long term capital gain is still lot lesser than your income tax. Other debt instruments like FD, NSC are added to your income and taxed as per your tax slab.
So, to have have expore to debt in your portfolio PPF and Debt MFs are a good buy.
The long term gain is taxed at 10% without indexation and 20% with indexation.
The short term capital gain is added to the taxable income of the individual and taxed according to applicable tax slab.
Actually STCG u/s 111A, (applicable in this case) is taxable @ 15% (+ EC + SEC).
You are right Praneet. It was 10% earlier and revised to 15% from AY 09-10. However, this is applicale only for equities held for less than 12 months.
For other capital assets if they are held for less than 36 months they are considered as STCG and are added to your income.