Explainer Economy

Demystifying debt funds as an investment option

A safer bet:  Debt funds are generally used by banks and corporates for their treasury operations.

A safer bet: Debt funds are generally used by banks and corporates for their treasury operations.

What are debt funds?

While equity funds invest mostly in shares of listed companies, debt funds invest in instruments like government bonds, commercial papers (CPs), certificate of deposits (CDs) and non-convertible debentures (NCDs). Debt funds invest in such securities and earn interest income that is shared among the investors after deducting the fund-management charges. By investing in such debt schemes, investors can indirectly invest in instruments like government bonds as well where direct retail investment is not possible.

What are the different types of debt funds?

Debt funds can be classified on the basis of the tenure of the bonds or instruments in which they invest. Liquid funds invest in instruments that have a tenure of less than 90 days. Then come the short-term funds that invest in instruments that typically have a tenure of three to six months. There are corporate debt funds too that could have a tenure of up to three years. The long-term funds would invest in bonds that have a tenure of three to five years or even more like in the case of government bonds (G-Secs).

Do retail investors invest in debt funds?

The share of real retail money in debt funds is still minuscule though the share is rising as more and more investors take to financial planning wherein a certain portion of the investment fund is allocated to debt products. Most fund houses now offer systematic investment plan (SIP) facility for debt funds as well. Interestingly, debt funds are popular among high net worth individuals (HNIs) to park their money temporarily before moving to other asset classes, mostly equity. Debt funds are generally used by banks and corporates for their treasury operations.

Are they better than bank deposits?

Debt funds offer more return than bank fixed deposits and that is one reason why many HNIs and institutions use such schemes for their treasury operations. While debt schemes offer comparatively higher returns, the risk is also higher compared to the safe FDs that offer assured returns. In the case of bonds, the price could fall due to various reasons thereby impacting its price and ultimately the return. There have been cases where the securities have been downgraded that has led to the scheme taking a hit. Taurus Mutual Fund, for instance, took such a hit early this year when Ballarpur Industries failed to honour its maturity obligation and the fund house had to mark down the CPs to zero.

What about tax liability?

The gains made on the investment in debt schemes are taxable. If the securities are sold within three years, it is considered short-term wherein the gains are added to the income of the investor and taxed as per the applicable tax bracket. If the securities are held for more than three years before selling, there are long-term capital gains tax.

The tax rate is 20% with indexation and 10% without indexation. Indexation refers to the mechanism wherein the gains are adjusted against the rate of inflation to derive the net taxable gains from the schemes.

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Printable version | Aug 10, 2022 6:44:52 am | https://www.thehindu.com/business/Economy/unwrapping-debt-funds-box-as-an-option-to-invest/article19245704.ece