To understand Bond Funds lets revise the meaning of Bond in financial market. Bonds are basically the money which you lend to the government or a company, and in return you can receive interest on your invested amount, which is back over predetermined amounts of time. Bonds are considered to be the most common lending investment traded on the market.
What is Bond Fund
So essentially, a Bond mutual fund will be combination of these bond investments as per the scheme objectives. These are also called as DEBT funds. Investing into bond funds is somewhat different from investing into a bond or a debt security directly. Especially in India, where the debt markets are underdeveloped, debt funds are sometimes the only way to invest in the debt market. The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors.
007 types of Bond/Debt Funds
Since debt funds invest into many kinds of debt securities, they are classified accordingly. Following are the most common classes of debt funds.
Liquid funds or Money Market Funds
Liquid funds are more suited for the investor with an investment horizon of about a month. In personal finance, ‘liquid’ means anything that is almost as good as cash. Money market funds or Liquid funds as they are commonly known as are one of the safest places to park your money for short periods of time. Typically, the funds invest into money market securities and debt securities that mature in 91 days.
Most companies and HNI park their short term money into these funds as liquid funds are more tax efficient than the interest one can get from the savings accounts.
Some of the benefits of parking money into liquid funds are, zero exit load on withdrawals, safety, low expense ratio and benefits of reinvesting the dividend.
Ultra Short Term Debt Funds
Ultra short term funds were earlier known as liquid plus funds and are slightly riskier in comparison to liquid funds. The funds invest into debt securities maturing in the next one year. Since ultra short term funds are riskier than liquid funds, they tend to give slightly higher returns in comparison to liquid funds.
Ultra short term funds share most of the benefits offered by liquid funds and suit investors who want to park their money for a few months.
Floaters or Floating Rate funds
Floating rate funds or Floaters invest into floating rate debt securities. Most of the debt securities in a floater fund will mature within a year. The main benefit of investing into a floater fund is that when the RBI increases the interest rates, the interest rates on floating rate debt securities also increase, thus when interest rates are expected to rise, floaters are better debt investments than other debt funds.
Floating rate funds invest 65% to 100% of their money into floating rate instruments and the rest in other debt securities.
Short Term Debt Funds
Short-term plans invest in shorter dated paper, i.e. debt paper with lower maturity. There is also significant chunk invested in cash/call money. This tends to insulate the fund from volatility in debt markets which impacts longer dated paper. Short term funds invest in debt securities that mature in the next 15 – 18 months. They invest mostly into AAA or AA+ rated debt securities and interest rate hikes mildly impact the returns. Short term funds are best suited for investors with an investment horizon of 1 – 2 years.
GILT Funds or Government Securities (G-Secs) Funds
GILT funds invest exclusively into debt securities issued by RBI on behalf of the Government of India or the state governments. Although there is no risk of default with G- Secs, they are not immune to the interest rate movements. Since G-Secs have no risk of default, they have a Sovereign (or SOV) rating.
G-Secs come with a wide range of maturities, from a few days to 30 years, so many GILT funds have short term and long term plans. Short term plans invest money into G-Secs which mature in the next 15-18 months. Long term plans invest into G-Secs which mature in periods up to the next 30 years.
Monthly Income Plans (MIPs)
Monthly Income Plans or MIPs are hybrid investment funds. They invest a minor portion (5% to 35%) in equities and the rest into debt securities. They aim to provide regular and periodic income. The income periods can be monthly, quarterly, half-yearly and yearly. But a point to be noted is that the income is not guaranteed. The fund will only be able to distribute income if it has surplus distributable income. These plans are suitable for people looking for regular income rather than capital appreciation.
Dynamic Bond Funds
Dynamic bond funds aim to bring active fund management into debt funds. They invest in debt securities with any maturity and invest across the yield curve, with the sole purpose of utilising any opportunity provided by inflation, changes in liquidity, changes in monetary policy, or government borrowing program factors. Apart from the earlier mentioned opportunities, dynamic bond funds also tend to use the inefficiency and volatility in the debt market to get better returns.