The financial year 2018-19 can best be termed as a horrible year for debt fund managers.

ILFS crisis, the consequent conflagration in the NBFC sector, collapsing prices of stocks pledged as collateral for debt securities issued by certain holding companies and subscribed to by mutual funds, and to cap it all, the “expose” by an investigative journalist website on alleged large scale “funds diversion” into the hands of the promoter of a housing finance company with heavy exposure to mutual funds are few culprits of the situation.

Most of these wounds are self-inflicted. Mutual funds relied more on generous ratings provided by external agencies, rather than rigorous internal due diligence.

In such a scenario building a stable debt oriented mutual fund portfolio is of utmost importance.

In this blog, I will be explaining how to build a debt fund portfolio which gives you stable returns over a short period of time. But first, let us know how many types of debt-oriented mutual funds are available in the Indian market.

Debt funds And Its Types

Debt fund is a type mutual fund which invests most of the money gathered from investors into fixed income instruments like corporate bonds, government bonds (both state and central), bonds issued by banks, certificate of deposit, treasury bills, etc.

Various types of debt fund available in the market are:

1. Gilt Fund

In gilt funds, investors invest their money in securities issued by both central and state government. There no risk associated with gilt funds as these are backed by the government.

However, these not completely risk-free and are vulnerable to change in interest rates. In fact, for long term investment in the gilt fund, they are the riskiest of all other debt funds available in the market due to their sensitivity to change in interest rates.

2. Income Funds

In income funds, investors invest their money in debt instruments like corporate debentures and government securities. Income funds are for investors with a high-risk appetite It works well for long-term investments since there is a high risk of change in interest rates.

So, invest in income funds if you want to gain from the change of interest rates over a longer period of time.

3. Monthly Income Plans ( MIPs )

MIPs is the mixture of equities (around 10-15%) and fixed income securities. MIPs are suitable for investors with big lumpsum amount and want a monthly income on their investment.

4. Short-Term Funds

If you want to invest for a shorter duration, say for 3-6 months, then these are best debt funds for you to invest in. Short term funds invest in papers like Commercial Paper(CPs) and Certificate of Deposit(CDs).

5. Ultra Short Term Funds

These funds invest in short-term debt securities with some small portion of long-term securities. The returns in this category are similar to the returns offered by short-term funds.

6. Liquid Funds

As the name suggests, these are the debt funds which can be easily converted in to cash that too within a working day or two. Liquid funds invest in highly liquid money market securities like Commercial Paper (CPs), Treasury Bills and Certificate of Deposit (CDs).

They invest in instruments with a maturity period of up to 91 days. Among all debt funds, liquid funds provide the most stable returns. Liquid funds are best suited for investors having a surplus amount lying idle in the savings bank account.

7. Fixed Maturity Funds

These funds have fixed maturity period, investing in papers with matching maturity. They take away the risk of change in interest rates by holding it to maturity. So, the NAV of the fund is not affected even if interest rates up and down.

8. Dynamic Mutual Funds

Dynamic funds switch aggressively between short term and long term debt funds. These funds invest across all classes of debt and money market instruments with no cap on maturity, or investment type. Returns are taxed as per your income tax slab if sold before three years and post that long-term capital gains tax applies.

9. Credit Opportunities

These are similar to dynamic funds as these invest in debt ranging from short term to long term with an objective to generate high-interest income. These funds are suitable for investors who are willing to take a risk for higher returns.

10. Debt-oriented hybrid funds

As the name suggests, invest mostly in debt and a small part of the corpus in equity. The equity part of the portfolio would provide extra returns, but the exposure also makes them a little risky.

How To Build A Stable Debt Fund Portfolio?

The very first thing to decide to build a stable portfolio is what are you investing for or what’s your investment goal.

The recent debacle in the world of debt funds was a painful one to go through, especially for investors who put money in such funds with the presumption of low risk and preservation of capital.

In such scenario, Short-term maturity papers are turning attractive and fund houses, too, are aligning their portfolio accordingly.

Ideally, you will be better off if you deploy your hard-earned money in short-term debt funds; but ensure you are giving due importance to your investment time horizon, asset allocation, and diversification. Consider investing in short-term debt funds for an investment horizon of 2-3 years.

If you have an investment horizon of 3 to 6 months and up to 2 years, ultra-short-term funds would be the most suitable.

If you wish to take the risk more, invest dynamically managed bond funds with an investment time horizon of over 3 years. An investment horizon of over 3 years will give you an additional tax advantage also.

And if you have an extreme short-term time horizon (say less than 3 months), you would be better off investing in liquid funds. These funds earn a higher return and are less volatile. Under the instant redemption facility, available for certain liquid schemes, it takes under 30 minutes to transfer the redemption amount to your bank account.

Always keep in mind that do not forget investing in debt funds is not risk-free.

Happy Investing!