Debt Consolidation

Debt Mutual Funds: Meaning, types, return, best debt funds India

Investment Mutual Funds

Debt funds are the open-ended mutual fund plans that generally invest in fixed-income securities. These are generally preferred by people who do not want to invest in a highly volatile market and want some certainty with their returns.

Companies or entities promise a steady and regular interest rate when they issue debt instruments. In simple terms, they ‘borrow’ (take debt) from investors when they wish to raise funds and provide interest in return. Hence, the name ‘Debt Funds’.

People generally have a lot of doubts regarding debt funds and that leads to a lot of confusion as well. This article will guide you through the entire concept of debt funds. You will find everything related to debt funds clarified here. So, without further ado, let’s start.

What is Debt Funds?

what are debt funds

Debt funds are a type of mutual fund that invests in securities of fixed income such as bonds and treasury bills. These funds could include several short term, mid-term, and long term bonds. Some examples of debt funds include the following:

  • Gilt fund
  • Monthly income plans (MIPs)
  • Liquid Funds
  • Fixed Maturity Plans (FMPs)
  • Short Term Plans (STPs)

How do Debt Funds work?

Debt fund managers make use of the credit ratings of various debt securities to determine and select the high-quality ones.

Every debt security comes with a credit rating through which investors understand the default possibility by the debt issuer in disbursing the principal invested along with the interest.

A debt security with a higher rating means that there is less probability of it defaulting.

However, debt funds also invest in low-quality debt securities. Fund managers choose securities based on several other factors too. Sometimes, they choose low-quality debt securities because those might earn higher returns later.

There is no reason to worry because the best fund manager always makes a calculated risk. But, debt funds that have high-quality securities in their portfolio are more stable. Also, a fund manager could invest in long-term or short-term debt securities based on whether the interest rates are falling or rising.

Types of Debt Funds

Debt Funds can be classified into the following types based on their maturity period:

1.  Liquid Fund

Liquid Fund is a type of fund that invests in money market instruments that have a maturity period of 91 days. Liquid funds, generally offer better returns (7% to 9%) when compared to bank Savings Account. So, these are a good alternative if you want to stay invested in the short term.

2.  Money Market Fund

Money Market Funds invest in money market instruments that have a maximum maturity period of 1 year. These are good for those investors who wish to stay invested for the short term and have a low-risk tolerance.

3.  Dynamic Bond Fund

These invest in debt securities with varying maturity periods as per the interest rate regime. These are good for investors having moderate risk tolerance and for those who want to stay invested for about 3 to 5 years.

4.  Corporate Bond Fund

Corporate Bond Funds invest a minimum of 80% of their total assets in corporate bonds that have the highest ratings. These are ideal for investors whose risk tolerance is low but they wish to invest in comparatively high-quality corporate bonds.

5.  Banking and PSU Fund

Banking and PSU Funds, like the name suggests, invest at least 80% of their portfolios in debt securities of PSUs (Public Sector Undertakings) and banking institutions.

6.  Gilt Fund

These invest at least 65% of their portfolios in corporate bonds with ratings below those of the highest quality corporate bonds. So, these funds do have some credit risk associated but they offer better returns when compared to the highest quality bonds.

7.  Credit Risk Fund

Credit Risk Funds invest a minimum of 65% of its portfolio in corporate bonds that have their ratings below the highest-rated corporate bonds. So, these funds do have credit risk associated with them but offer slightly better returns when compared to the highest quality bonds.

8.  Floater Fund

These invest a minimum of 65% of its investible corpus in floating-rate investments. Floater funds have a low interest-rate risk associated.

9.  Overnight Fund

As the name suggests, Overnight Funds invest in debt securities with a maturity period of 1 day. Such funds are very safe to invest in as both credit risk and interest rate risk associated with them is minimal to negligible.

10. Ultra-Short Duration Fund

This fund invests in money market instruments and debt securities in such a manner that the Macaulay duration of the fund is from 3 to 6 months.

11. Low Duration Fund

Low duration debt funds type of fund invests in money market instruments and debt securities in such a manner that the Macaulay duration of the fund is from 6 to 12 months.

12. Short Duration Fund

Short-term debt mutual funds invest in debt securities and other money market instruments in such a manner that the Macaulay duration of this fund is from 1 to 3 years.

13. Medium Duration Fund

Medium duration funds invest in debt securities and other money market instruments in such a way that their Macaulay duration ranges from 3 to 4 years.

14. Medium to Long Duration Fund

This type of fund invests in money market instruments and debt securities in such a manner that the Macaulay duration of this fund is from 4 to 7 years.

15. Long Duration Fund

The long term debt funds invest in money market instruments and debt securities in such a manner that the Macaulay duration is more than 7 years.

Who should invest in debt funds?

Debt funds are ideal for investors with low-risk tolerance. Debt funds usually diversify their portfolios across several securities to make sure that you get stable returns. But, there is no guarantee whatsoever.

Usually, the returns received fall in the range of expectations. So, debt mutual funds are suited for low-risk investors. These are also recommended to the following group of people:

Short-term investors (3 to 12 months): A regular Savings Account interest rate has dropped and ranges from 3% to 6%. But, liquid funds offer a 7% to 9% interest rate. So, this way you will get higher returns without having to compromise on the liquidity of your investment.

Medium-term investors (3 to 5 years): Investors who wish to invest in a low-risk investment tool for 3 to 5 years usually would think of a bank Fixed Deposit as the safest option. However, a dynamic bond fund will offer better returns than FDs for the same tenure. Besides, if you want to invest in FD to receive the monthly interest payouts, then there is an alternative with debt fund investments as well. A Monthly Income Plan will provide monthly payouts just like the interest paid out by FDs.

Why should you buy Debt Funds?

The following reasons will tell you why you should invest in debt funds:

1.  Regular Income Source

Debt funds are an ideal investment option if you want a regular income source. You should choose the dividend payout option if you want your investment to provide you with a regular income source.

2.  Anytime withdrawal

Investors can withdraw the required money from your investment at any time as per your requirement and the rest of the money can stay invested.

3.  Stability

Debt Funds invest largely in Government securities, corporate debts, and other securities such as treasury bills, etc. Such funds are immune to equity market volatility.

4.  For achieving short term goals

This is a good option for achieving short-term goals as well. You could try investing in debt funds like ultra-short-term funds, liquid funds, etc. for your short-term financial goals.

5.  SWP

Systemic Withdrawal Plan (SWP) is the exact opposite of SIP Plans. Through SWP, you will be able to withdraw a fixed income every month from your debt fund investment. You can alter the SWP amount as and when required.

How to invest in debt funds?

Just like other mutual funds, you can invest in debt funds in two modes: Online or Offline. Given below are the steps to invest online and offline in debt funds in India.

Steps to invest in debt funds in India


  1. Go to the website of the Asset Management Company that is offering the fund or you can also go to the online partner platforms.
  2. Register yourself/ make an account.
  3. Fill in the details of the form.
  4. Complete your KYC.
  5. Provide the required documents.
  6. Pay the first month’s premium (if you are investing in a debt fund with the best SIP plans) or pay the lump sum.
  7. Soon, you will receive a confirmation text or email.


For offline investment, you would need to fill-up the form and submit it at the nearby branch of the fund house along with the required documents. Else, you could invest via a broker.

Top 10 Best Debt Funds to Invest in 2020

[table id=16 /]

1.  ICICI Prudential Long Term Plan

ICICI Prudential Long Term Plan aims to generate income via a range of debt and money market instruments that have different maturities.

This in turn maximizes the income generated and also maintains a balance among returns, safety, and liquidity.

This is one of the best debt-dynamic bonds and its 2019 returns were at 10.2%. In 2020 as well, it has retained its reputation as one of the top debt funds. It was launched back on 20th January 2010.

Minimum Investment 5,000
Minimum SIP Investment 100
1 Year Returns (%) 12%
3 Year Returns (%) 8%
5 Year Returns (%) 9.6%
2019 Returns (%) 10.2%

2.  Aditya Birla Sun Life Corporate Bond Fund

Aditya Birla Sun Life Short Term Fund aka Aditya Birla Sun Life Corporate Bond Fund is an open-ended income scheme. It invests its entire corpus in a variety of debt and money market securities to create a diverse portfolio. This makes it one of the best debt mutual funds in 2020.

It is a Debt-Corporate Bond fund. Launched back on 3rd March 1997, this fund has provided an annualized return of 9.4% and has moderate risk associated.

Minimum Investment 1000
Minimum SIP Investment 100
1 Year Returns (%) 11.6%
3 Year Returns (%) 8.9%
5 Year Returns (%) 9%
2019 Returns (%) 9.6%

3.  HDFC Corporate Bond Fund

HDFC Corporate Bond Fund generates regular returns via investments made in Debt/Money Market Instruments and Government Securities that have a maximum maturity period of 60 months.

Launched on 29th June 2010, this is a moderately low-risk fund and has given 10.3% returns in 2019.

Minimum Investment 5,000
Minimum SIP Investment 500
1 Year Returns (%) 11.1%
3 Year Returns (%) 8.7%
5 Year Returns (%) 9%
2019 Returns (%) 10.3%

4.  HDFC Banking and PSU Debt Fund

HDFC Banking and PSU Debt Fund is a Debt-Banking and PSU Debt fund. It generates regular income by making investments in debt and money market securities that mainly comprise of securities issued by Scheduled Commercial Banks and Public Sector Undertakings.

It was launched on 26th March 2014 and has provided an annualized return of 8.9%.

Minimum Investment 5,000
Minimum SIP Investment 500
1 Year Returns (%) 10.9%
3 Year Returns (%) 8.2%
5 Year Returns (%) 8.8%
2019 Returns (%) 10.2%

5.  PGIM India Short Maturity Fund

PGIM India Short Maturity Funds is a short term Debt Fund and provides steady income by investing in short to medium debt and money market instruments. It was launched on 21st January 2003 and has had a CAGR return of 7.3% ever since.

Minimum Investment 5,000
Minimum SIP Investment 500
1 Year Returns (%) 9.2%
3 Year Returns (%) 3.9%
5 Year Returns (%) 6%
2019 Returns (%) -0.5%

6.  Franklin India Dynamic Accrual Direct Plan

This fund aims to provide you with a steady income via investments of high credit quality and highly liquid money market instruments.

1 Year Returns (%) 9.79%
3 Year Returns (%) 9.29%
5 Year Returns (%) 10.42%

7.  Nippon India Gilt Securities Fund

Nippon India Gilt Securities fund invests mainly in debt securities issued by the Central and State Governments. This ensures that you receive returns with minimal returns.

It is one of the safest debt funds when it comes to credit risk as the government wouldn’t most likely default on the interest and principal payment. This fund is ideal for long term investments for wealth creation.

1 Year Returns (%) 9.69%
3 Year Returns (%) 10.17%
5 Year Returns (%) 9.52%

8.  SBI Magnum Medium Duration

SBI Magnum Medium Duration fund invests primarily in short term debt securities and ensures that you receive regular returns. It also invests in medium securities for capital appreciation.

The credit risk associated is well-diversified and the maturity period is around 3 to 4 years. It has a moderate level of liquidity. Hence, this is one of the best debt funds to invest in 2020

1 Year Returns (%) 9.13 %
3 Year Returns (%) 10.09%
5 Year Returns (%) 10.13%

9.  Kotak Credit Risk Fund

Kotak Credit Risk Fund is an open-ended debt scheme that mainly invests in debt and money market securities to deliver high returns. The credit risk associated, however, is a little higher.

It follows an investment strategy that focuses on selling low-yield securities, and on the other hand, buying high-yielding securities. This fund is ideal for investors with a moderate risk appetite but a little high credit risk.

1 Year Returns (%) 6.96%
3 Year Returns (%) 8.61%
5 Year Returns (%) 8.77%

10. ICICI Prudential Ultra Short Term Fund

ICICI Prudential Ultra Short Term Fund is an open-ended debt scheme that primarily invests in securities with a maturity period of 3 months to 6 months. It has limited investment in government securities as this reduces the interest rate volatility.

This fund has a thorough fund selection procedure and picks securities with a high credit rating. It effectively increases yield and decreases associated risks.

1 Year Returns (%) 7.98 %
3 Year Returns (%) 8.97%
5 Year Returns (%) 8.89%

Benefits of investing in debt funds

Guaranteed or Safest returns with Debt funds:

debt funds returns

Debt funds invest mainly in securities that give fixed interest returns. Still, there is a tiny bit of probability that the debt fund would not perform as expected.

However, this possibility is extremely low and happens only when the investment has been made in low credit-rated securities, or the interest rate movement is in the negative range.

Also, debt fund returns are better than your bank FD returns.

You can safely place your idle money in debt funds


Overnight funds or liquid funds also fall under the debt funds, and these have continuously delivered optimal returns over the years when the investment made is of short term. These have high liquidity and are perfectly safe for parking your idle money. Also, as these have high liquidity, so you can easily redeem the units whenever you want to.

Better returns

Debt funds provide better returns when compared to the returns provided by the traditional saving methods like Bank Fixed Deposits or Savings Accounts. Savings Accounts deliver an interest rate of 3% to 5% on average but debt funds, especially liquid funds have an average return rate of 7%.

Diversified Portfolio

It is advised that you should construct a diverse investment portfolio. Try to invest in such a debt fund that has a proper allocation in various money market instruments and does not focus on only one debt security.

Better than investing in a single debt security

In a debt fund, a fund manager will formulate a portfolio consisting of various securities, after analyzing market conditions properly. Besides, the fund manager will also consider several other factors like interest rate movements, etc. which might influence your debt fund. So, you should invest in a debt fund instead of selecting single debt security.

How to Evaluate Best Debt Mutual Funds as an Investor 

The following points will help you in choosing the top debt funds in India:

1.  Investment Goal:

If your investment objective is set to clear in your mind, then you will be able to narrow down the debt fund categories accordingly. Your investment objective could be anything like parking surplus money, finding a better alternative to bank FDs, a short-term goal, generating a secondary income source, etc.

2.  Investment horizon

Make sure to check the investment horizon while shortlisting debt funds. This will help you in minimizing the interest risk rate.

3.  Credit Quality

Stick to debt mutual fund schemes with high credit quality papers and high ratings. This way the credit risk associated with your debt fund will be decreased.

4.  Fund Size

If you want to decrease the concentration risk associated with your debt fund, then ensure that you invest in a fund with a large AUM. Besides, this will also protect you from redemption pressures. The top debt mutual funds come from fund-houses having high fund sizes.

5.  Expense Ratio

Pick a fund with a relatively lower expense ratio. That ensures better returns. The returns received from debt funds are lower than those from equity mutual funds. So, funds with low expense ratios are considered to be good debt funds.

6.  History of debt fund

You can compare past performances of the funds. But, keep in mind that past performance might not be repeated in the future. The best performing debt funds change every year.

7.  Risk appetite

Debt funds do have some risk associated and are not entirely risk-free. These funds are usually exposed to credit risk and interest risk. So, analyze the debt fund’s performance and portfolio allocation properly to get to know about the risk associated with it.

8.  Exit Load

Some debt funds do charge an exit load to discourage premature withdrawal from the fund. Take this point into consideration and try to pick a fund with zero exit load.

You may like to Read: Best Index Funds in India 2020: Benefits & How to Invest in Index Funds

Risks in Debt Fund investments

risk in debt funds

Debt funds have 3 types of risks associated with them. Find them explained below:

  1. Credit Risk: This is the default risk associated with debt funds which involve the issuer not repaying the principal amount and the interest associated.
  2. Interest Rate Risk: This is the type of risk that happens due to the effect of changing interest rates on the value of the fund’s securities.
  3. Liquidity Risk: This type of risk is of the fund house and happens when it does not have adequate liquidity to meet the current redemption requests.

Is Debt Fund better than FD?

Before concluding, let’s compare debt funds and FDs based on the following parameters:

  • Returns

The banks have lowered their FD interest rates. Debt funds have historically delivered return rates in the range of 7% to 9% p.a. While banks offer a maximum interest rate of 7% on an average on FDs. So debt fund interest rate is generally better than that of FDs.

  • Liquidity

Some debt funds like open-ended debt funds, liquid funds, etc. are highly liquefiable. While if you go for premature withdrawal of an FD, then the bank will penalize you with a lower interest than the original booked interest rate. Some FDs don’t even allow premature withdrawal as they have a lock-in period of 5 years.

  • Risk

Bank FDs have zero risks associated with them. On the other hand, debt funds are considered to have some risk associated. However, the risk in debt funds are very low and often considered to be comparable to that of FDs.

  • Taxation

Debt funds generate higher post-tax returns when compared to bank FDs if you choose to stay invested for more than 3 years.

Hence, you can see that bank FDs are outscored by Debt Funds when it comes to returns, variety, liquidity, and taxation. Also, there are several types of debt mutual funds to choose from. Still, bank FDs have no risk associated and there is a certainty of returns. This is not provided by debt funds. However, if you choose debt funds wisely, then these risks are often mitigated.

You may like to Read: Best Tax saving Mutual Funds: Best ELSS Mutual funds in 2020

Which is a better liquid fund or debt fund?

Liquid Funds have gained massive popularity over the years. However, many people don’t know that liquid funds are a subset of debt funds. So, the two terms cannot be used interchangeably.

While answering whether liquid funds are better than other debt funds or not, you need to consider your risk profile, investment goal, and other factors. The answer would be different for everyone.

What is the difference between debt fund and liquid fund?

Liquid funds have the lowest risk amongst all the debt funds. This is because the interest rate risk and credit risk associated with liquid funds is the minimum. While other debt funds have a varying range of risk profiles. So, if your risk tolerance is low, then liquid funds should be your choice as these are the safest debt funds.

Not all categories of debt funds are as liquid as debt funds. Liquid funds are called so because they offer high liquidity. So, if you want to redeem your fund anytime, then liquid funds are a better option.

Various debt funds have varying maturity periods. There are overnight funds that have a maturity period of one day and on the other hand, we have gilt funds, which will force you to stay invested for 10 years.

Liquid funds have a maximum maturity period of 91 days. So, you can see for yourself that the maturity periods of different debt funds are different. Hence, you need to choose based on your requirement.

How are debt funds taxed?

Debt funds are taxed in the following manner:

Short Term Capital Gains

If you hold your debt funds for less than 36 months, then the returns you earn on this short-term investment will be known as short-term capital gains.

For instance, if you have invested INR 60,000 in a debt mutual fund, and end up withdrawing the amount before 36 months/ 3 years of investment. Then STCG or Short Term Capital Gains Tax will be levied as per your income tax slab.

Long Term Capital Gains

If your debt investment’s holding period is more than 36 months, then the investment is known as a long-term investment. The returns on this kind of investment will be taxed at the rate of 20% along with the benefit of indexation. The indexation will reduce the value of your overall LTCG (Long Term Capital Gains).

What is the average maturity in debt funds?

Average Maturity is the weighted average of all of the current maturities of the debt securities your portfolio holds. It gives you an idea about the mean age of every debt security in your fund portfolio.

The higher the average maturity of a debt fund, the longer it takes for each security to maturity and vice-versa.

The average maturity keeps varying and has an important impact on the fund’s overall returns and risk associated. You need to match your investment horizon with the average maturity of your fund securities.

All in all, you can say that longer average maturity is equivalent to the higher risk associated with the fund and higher volatility too, and vice versa. Also, make sure to align the average maturity with the investment horizon of the debt fund.


By now, you must have received a fair idea about debt funds. We have listed the benefits of investing in debt funds along with the risks associated as well. The list of top debt funds, will hopefully, help you decide as per your requirement.

We would reiterate it that while investing in debt funds, focus more on the credit risk, duration, etc. rather than analyzing via past returns. Let us know if you have any doubts or if we have missed something, in the comments below.


  1. Is it safe to invest in debt funds?

Yes, debt funds are one of the safest investment options available out there. They have consistently provided fixed returns with low risk.

  1. Is there any exit load on debt funds?

Exit load is the charge deducted at the source if you withdraw your investment earlier than its decided tenure. Debt funds do not have any lock-in period, but still, some funds might have an exit load associated to discourage premature withdrawals. However, some debt funds carry zero exit load too.

  1. Are debt fund returns always positive?

Debt Fund returns are generally positive. But, long term debt might deliver negative returns when the interest rate surges.

  1. What are the top short-term debt funds?

The best short-term debt funds you could consider investing in 2020 are as follows:

  1. ICICI Prudential Savings Fund
  2. IDFC Bond Short Term Fund
  3. Axis Short Term Fund
  4. Kotak Low Duration Fund
  5. HDFC Short Term Debt Fund
  6. Why are debt funds better than FDs?

Debt funds are better than FDs in terms of taxability, returns, liquidity, etc. Check this for a detailed analysis.

  1. Is liquid fund a type of debt fund?

Yes, the liquid fund is a type of debt fund with high liquidity and a maximum maturity period of 91 days.

  1. Do debt funds have a lock-in period?

No, debt funds do not have a lock-in period. You have the complete freedom to withdraw your invested amount or some part of it anytime.

  1. Is debt fund risk-free?

No, debt funds are usually low-risk investments. But, they do have some risk associated. This will provide you with a better insight into the risks associated with debt funds.

  1. What do debt funds invest in?

Debt Funds primarily invest in securities that create fixed returns/ income such as corporate bonds, government securities, treasury bills, and other money-market securities.

  1. How do I invest in a debt fund?

You can invest in debt funds either online or offline. See this for more information.