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Decoding Debt Funds

Personal financial needs should dictate your fund choices

I have determined how much money I would like to allocate to debt instruments, which are a mix of short-, medium- and long-term products. But, I'm often puzzled as to when to move into floating rate funds, Gilt funds, income funds, or so many other types of funds that make up the debt universe. Please advice.

- Ravish

Different categories of debt funds are used to fulfil different purposes. Your debt portfolio need not be actively managed. The most important factor, while choosing debt funds, is their portfolio maturities. The higher the maturity, the more volatile it is to interest rate changes which are inversely related to the prices of fixed income instruments.

Liquid, Short-term Floating Rate and Liquid Plus funds are best used to park short-term monies. They invest in money market instruments, and cash and cash equivalents. They can also be used as emergency funds, but are not as liquid as money in the bank accounts.

Short-term debt funds and medium-term debt funds can provide better returns over a longer time-frame, say 2-5 years, as compared to the liquid funds. They invest in higher maturity papers such as corporate debt and government securities. Medium-term debt funds are more volatile as compared to the short-term debt funds, which in turn are more volatile as compared to liquid/liquid plus funds.

Gilt funds, which primarily invest in government securities, are the most volatile due to their high maturities which may go as high as 20 years, even more at times. They can generate high returns when interest rates are falling, but suffer most when interest rates rise.

Apart from these, there are flexi debt funds which actively move between different maturities, but they are also more risky.

If you are investing for the long-term, then you can use the short-term, medium-term or flexi debt funds, or even bank fixed deposits.

Some good funds are Kotak Flexi Debt, Canara Robeco Income, Reliance Short-term, UTI Short-term Income Fund.

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