What are Debt Funds: All about Debt Funds
If you’re looking for a market-linked investment option that’s not as risky as equity but has the potential to deliver moderate returns, debt instruments may just be the one for you. One of the best ways to invest in these instruments is through debt mutual funds. They’re easy to invest in, offer much stabler returns and reduce your portfolio risk through diversification.
If you’re new to debt funds or are unaware of what they are, here’s a comprehensive guide on everything you need to know about these funds.
What are Debt Funds?
Debt funds are mutual funds that use the money pooled from investors to invest in a wide range of debt instruments of varying tenures. Some of the debt instruments that these funds invest in include corporate bonds and debentures, government bonds and money market instruments like Commercial Papers (CPs) and Certificates of Deposits (CDs).
Benefits of Investing in Debt Funds
Debt funds offer a multitude of different advantages. Let’s take a closer look at some of the key benefits of this investment option.
Stable Returns
As you now know, debt mutual funds invest in debt instruments, which are fixed-income securities. These securities provide you with a steady source of income by way of interest payments throughout the entire tenure. By investing in such funds, you can create a stable source of income which is not the case with equity funds.
Portfolio Diversification
Diversification is a technique where you invest in different investment options and asset classes to bring down risk. Debt funds enable you to achieve just that. If your portfolio primarily consists of equity instruments, investing in debt funds can help reduce risk through diversification.
Lower Risk
The returns from equity funds are heavily dependent on market performance. However, that’s not the case for debt mutual funds. Since they consist of fixed-income securities, you would get interest payments from your investments irrespective of how the market moves.
Multiple Types Of Debt Funds
One of the major advantages of debt funds is that you get the freedom to choose the kind of fund that you wish to invest in. For instance, if you wish to go by the investment horizon, you have short-term and long-term funds to choose from. Alternatively, if you wish to go by the kind of debt instruments the funds invest in, you have money market funds, gilt funds and corporate bond funds, among others.
Risks Associated with Debt Funds
Debt funds are not completely free from risk. In fact, there are four major risks that you need to factor in when investing in such a fund. Here’s a brief overview of these risks.
Interest Rate Risk
When the interest rates in the market rise, the value of bonds goes down. The interest rate risk is defined as the possibility of the interest rates rising after you invest in debt funds, leading to a fall in the Net Asset Value (NAV).
Credit Risk
Debt funds also invest in corporate bonds. The possibility of the company defaulting on its interest or principal payments is known as credit risk. Funds that invest in high-risk corporate bonds often have higher credit risk.
Inflation Risk
Inflation risk is the possibility of the returns from your debt fund being lower than the rate of inflation. Debt funds with low-yield bonds, despite being safer to invest, often have higher inflation risk.
Liquidity Risk
Liquidity risk is the possibility of not being able to sell the units of the debt mutual fund in the market. Debt funds that invest in high-risk bonds and unlisted and illiquid debt instruments have higher liquidity risk.
How to Choose The Right Debt Fund?
With so many debt mutual funds in the market, it is important to choose the right fund to invest in. Here are a few factors that you can consider when evaluating debt funds.
Risk Tolerance
The ability to tolerate risk varies from one investor to another. Therefore, it is one of the primary factors you need to consider when selecting a debt fund. The credit and risk profile of the fund should always match your risk tolerance.
For instance, if your risk tolerance levels are low, consider investing in gilt funds since they don’t have any credit risk. Alternatively, if you have a high-risk tolerance, you may choose to invest in credit opportunities funds. These funds invest in lower-rated debt instruments but offer higher returns.Investment Horizon
The period of investment is another major factor that you need to consider. You should always invest in a debt fund with tenures that match the number of years you wish to stay invested. For instance, if you don’t plan on holding your investments for more than a year, short-term debt mutual funds like money market funds may be what you’re looking for. On the other hand, if you’re willing to stay invested for a few years, you may consider investing in long-term debt funds.
Interest Rate Expectations
How you expect the interest rates to fare in the future should also be taken into consideration when evaluating a debt fund. If you expect the interest rates to rise in the future, you may want to invest in short-term or liquid funds. Alternatively, if you expect the interest rates to fall, investing in long-term funds may be the right way to go.
Conclusion
With this, you must now be aware of what debt funds are and their benefits and risks. Investing in debt funds is a great way to get stable and consistent returns. However, you should keep in mind that the returns are not always guaranteed.
Wish to invest in debt mutual funds? m.Stock’s trading and investment platform allows you to invest in a wide range of debt and other mutual funds in just a couple of clicks. Furthermore, you can even get up to 1% extra returns on direct mutual fund investments you make through m.Stock.
SIPs let you invest small amounts regularly, making it easier to stay consistent with your goals. With time, your money grows faster through compounding, helping you get the most out of your investments. Try our SIP Calculator to see how your money can grow and make smarter plans for your future.
More Related Articles
Can Mutual Fund Schemes Invest in Upcoming IPOs?
18 July 2025 | 7 mins read
Can Mutual Fund Schemes Invest in Upcoming IPOs? - H1 Initial Public Offerings (IPOs) have become a buzzword among investors looking for high-growth opportunities. Whether it’s a unicorn startup going public or a reputed company entering the equity market, IPOs attract substantial interest. But what about mutual funds — can they participate in IPOs? And if yes, how does it impact you as an investor in a mutual fund? This article explores the role of mutual funds that invest in IPOs, the process behind such investments, and how you can benefit from this strategy. You’ll also gain insights into how fund managers evaluate IPO opportunities and which mutual funds are more likely to invest in them. Role of Mutual Funds in Equity Markets - H2 Mutual funds play a vital role in India’s equity markets. Managed by professional fund managers, these pooled investment vehicles collect money from multiple investors and allocate it across a portfolio of stocks, bonds, or other assets based on the fund's mandate. In the context of equity investing, mutual funds: Provide diversification to small investors Help in price discovery and market depth Act as long-term institutional investors Reduce risk through strategic asset allocation Given their market presence and influence, mutual funds also participate in IPOs, often subscribing to large portions of new issuances. But this activity is more nuanced than simply bidding for shares. Are Mutual Funds Allowed to Invest in IPOs? - H2 Yes, mutual funds in India are allowed to invest in IPOs — both in the primary market (where shares are first issued) and in the secondary market (where stocks are traded after listing). This means mutual funds can apply for shares during an IPO’s book-building process just like retail investors, high-net-worth individuals (HNIs), and institutional investors. SEBI regulations allow fund managers to allocate a portion of the fund’s assets to IPOs, provided the investment aligns with the scheme's objectives and risk profile. For instance: A large-cap fund may only invest in IPOs of companies expected to be included in large-cap indices A multi-cap or flexi-cap fund has more flexibility to take exposure across market capitalisations, including IPOs An ELSS fund (Equity-Linked Savings Scheme) can also participate in IPOs if it aligns with its tax-saving and equity investment objective So, the short answer is: Yes, mutual funds can and do invest in IPOs — but not all funds, and not always. Why and When Do Mutual Funds Invest in IPOs? - H2 Investing in IPOs offers mutual fund managers several strategic advantages, including: 1. Access to Early Growth Potential - H3 Many IPOs are of young, fast-growing companies. By investing early, mutual funds aim to capture the growth upside before the stock gains mainstream popularity. 2. Price Arbitrage Opportunities - H3 If a mutual fund believes that the IPO is underpriced relative to its intrinsic value, it may invest with the intent of benefiting from listing gains or long-term appreciation. 3. Portfolio Enhancement - H3 Some IPOs bring fresh sector exposure or innovation to the market. Fund managers may invest to diversify or rebalance the portfolio with new-age businesses, like fintech or EV startups. 4. Long-Term Bets - H3 Fund managers often look at IPOs with a long-term lens. The goal isn’t always listing gains but building a position in a company expected to perform well over years. 5. Demand and Liquidity Trends - H3 In bullish markets, IPOs tend to be oversubscribed and see strong listing premiums. Mutual funds may participate to ride the market momentum, especially when investor confidence is high. Factors Fund Managers Consider Before Investing in IPOs - H2 While IPOs are exciting, they are also risky and speculative, especially for companies with no prior listing record. Fund managers conduct rigorous due diligence before deciding to allocate your money to an IPO. Here are the key factors considered: 1. Company Fundamentals - H3 This includes examining the company’s: Revenue and earnings trends Debt levels and capital structure Profit margins and business scalability Competitive advantage and market share 2. Valuation Metrics - H3 Fund managers analyse: Price-to-Earnings (P/E) ratio Price-to-Book (P/B) ratio Enterprise Value to EBITDA (EV/EBITDA) These are compared with listed peers in the same sector. 3. Promoter and Management Track Record - H3 A critical evaluation is made on the credibility, governance standards, and historical performance of the promoters and top management. 4. Utilisation of IPO Proceeds - H3 Fund managers study how the company plans to use the funds—whether for debt repayment, expansion, or general corporate purposes. 5. Macroeconomic and Sector Trends - H3 Sectoral outlooks, regulatory policies, and broader market sentiments also influence IPO investment decisions. 6. Anchor Book Participation - H3 Strong interest from anchor investors (like global funds or sovereign wealth funds) signals confidence in the issue, making it more attractive for mutual fund participation. Best IPO Mutual Funds: What to Look For - H2 If you're keen on gaining exposure to IPOs through mutual funds, it's important to choose the right type of fund. While there’s no official category called “IPO mutual funds,” some schemes actively participate in upcoming IPOs. Here’s what you should look for when selecting such a fund: 1. Fund Category and Investment Mandate - H3 Start by checking the category of the fund. Flexi-cap, multi-cap, and mid-cap funds generally have more leeway to invest in IPOs. These funds are not restricted to a single market capitalisation and often aim to capture high-growth opportunities, making them ideal for IPO exposure. 2. Track Record of Participating in IPOs - H3 Review the fund’s portfolio history. Some mutual funds consistently allocate a portion of their assets to new listings. You can find this information in the fund’s monthly factsheet or portfolio disclosure. Look for funds that have a pattern of investing in IPOs over time—not just as a one-off move. 3. Fund Manager's Experience and Strategy - H3 A skilled fund manager makes a significant difference. The manager's ability to evaluate IPO valuations, industry potential, and company fundamentals is crucial. Look for funds managed by professionals with a proven track record in equity investing and a sound IPO selection approach. 4. Diversification and Risk Management - H3 An ideal fund won’t rely heavily on IPOs alone. Instead, it will use IPO investments as part of a broader equity strategy. Ensure that the fund holds a well-diversified portfolio alongside its IPO allocations to reduce volatility and balance risk. 5. Consistent Performance Over Market Cycles - H3 While past performance isn’t a guarantee of future returns, funds that have consistently performed well across different market cycles often reflect strong management and strategy. Look at long-term performance metrics like 3-year or 5-year returns instead of just recent gains. 6. Transparency and Reporting - H3 Good IPO-investing funds are transparent about their holdings. Choose funds that provide detailed disclosures about their portfolio, including new IPO allocations, so you can track how your money is being deployed. Also, read the scheme information document (SID) to understand the fund’s mandate and whether it allows active IPO participation. Should You Invest in a Mutual Fund That Invests in IPOs? - H2 Pros: Access to IPOs without applying individually Professional due diligence and analysis Built-in diversification Potential to capture high-growth opportunities Cons: IPO investments may not always succeed May increase portfolio volatility Returns can be affected by market timing and sentiment If you're a long-term investor, funds that occasionally invest in IPOs can be a good addition to your portfolio — but don’t chase IPO exposure alone. Always assess the fund holistically. Conclusion - H2 Yes, mutual fund schemes in India can and do invest in IPOs, but they do so strategically — not emotionally or impulsively. Fund managers assess multiple factors before deciding to put your money in newly-listed companies. As a retail investor, you benefit from their expertise and risk management process without having to analyse IPOs on your own. If you're looking for exposure to IPOs but want to avoid direct stock-picking, investing in a mutual fund that invest in IPO offers a smart, diversified route. However, always match the fund’s strategy with your risk tolerance, time horizon, and financial goals.
Mistakes People Make While Investing and How to Fix Them
10 July 2025 | 7 mins read
Investing can be one of the most effective ways to build wealth over time. Whether you’re investing in mutual funds or stocks, the goal is simple: earning returns that beat inflation and help you achieve financial freedom. However, investing isn’t just about selecting the right stocks or funds — it’s also about avoiding costly mistakes that can slow your progress down.
How Can ELSS Funds Be Redeemed? Rules for ELSS Withdrawal
26 June 2025 | 9 mins read
Equity-linked Savings Schemes (ELSS) are a type of mutual fund in India that provide tax relief under Section 80C of the Income Tax Act. ELSS have a three-year lock-in period, during which the amount invested cannot be withdrawn. It is important for investors to know the ELSS redemption process, rules, and tax implications while making their financial plans. This article explores the intricacies of ELSS mutual fund redemption, shedding light on the procedures and considerations.