DEBT MUTUAL FUND

What is a Mutual Fund?

 A mutual fund is an investment vehicle made up of a pool of money collected from many

investors for the purpose of investing in securities such as stocks, bonds, money market
instruments and other assets.
 Professional Management - Mutual funds are operated by professional money managers,
who allocate the fund's investments and attempt to produce capital gains and/or income for
the fund's investors.
 Structured investment - A mutual fund's portfolio is structured and maintained to match the
investment objectives stated in its prospectus.
 Mitigation of risks - Mutual Fund is a tool by which an investor, particularly retail investor
who lacks understanding and experience in dealings of capital markets, attain benefits of
diversification and mitigation of risk.
 Pooling of Money - Mutual Fund mobilizes money from investors by selling units of total
capital invested in different financial instruments issued by corporates, government and
other entities as per the defined investment objective.

Structure of Mutual Funds

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Fund Sponsor – a person or entity that establishes mutual fund

Trustees – A mutual fund can be managed by board of trustees,which is a body of individuals or by a
trust compamy which is a corporate entity.

AMC – company constituted by trustess which acts as investment mangers of the trust

Custodian – organisation established for safekeeping of securities and other assets of mutual Fund

R&T agent – they maintain records of all unit holders of MF.Communication between MF and
investor happens thru R&T agent

Distributors – agents who undertake distribution of mutual fund schemes and earn commission.

Classification of Mutual Funds

The new mutual fund categorization norms announced by SEBI call for reclassification of schemes
by all the mutual funds.

Indian mutual funds offered over 2,000 mutual fund schemes across 40 AMCs. Each scheme had a
direct plan and a normal plan and each plan had a dividend option and a growth option. For a
mutual fund investor, this was just too confusing. Moreover, the larger AMCs with more than
Rs.200,000cr in AUM would have multiple equity schemes with different names but the same
structure. This made the choice tough for the mutual fund investor.

How and why of reclassification

As shown in the classification chart,

 SEBI has defined 10 categories for equity funds, 16 for debt funds, 6 for hybrid funds and
2 for special situation funds.
While hybrid funds combine equity and debt, the special situations funds offer goal-
based solutions for retirement planning and for creating a children’s fund.
 Each AMC can only have 1 scheme under each of these 34 categories shown in the below
above.
However, there is a fifth category “Others”, which will consist of all other funds like index
funds, ETFs, gold funds, Fund of Funds etc. Funds can have any number of schemes
under this category. SEBI’s contention has been, and rightly so, that this classification
gives greater clarity to the mutual fund investors about what is the investment portfolio
that they are investing in. The communication is much clearer to the investor and
comparison across funds becomes more meaningful.
DEBT FUNDS
 Debt funds are those category of mutual funds that primarily invests in bonds (corporate
and government),gilts,treasury bills and other money market instruments.
 Such funds are suitable for investors who are risk averse and does not want to operate in
highly volatile and dynamic environment which equities are subjected to.
 From tax implications point of view,investment below three years are considered as
short term and three years are above are considered long term investments.
  Income from debt funds are taxed in short term as per an individuals/company’s income
tax slab applicable.Long term gains are taxed at the rate of 20% with indexation.

Indextation - Indexation is a system or technique used by organizations or governments to connect

prices and asset values to inflation. This is done by linking adjustments made to the value of a good,
service or other metric, to a predetermined index. 

Overnight Debt Fund

The overnight market is the component of the money market involving the shortest

term loan. Lenders agree to lend borrowers funds only "overnight" i.e. the borrower must repay the
borrowed funds plus interest at the start of business the next day. Given the short period of the
loan, the interest rate charged in the overnight market, known as the overnight rate is, generally
speaking, the lowest rate at which banks lend money.
Mutual Funds also participate in overnight market when they have have a fund with such an
investment rationale or they have excess funds to park/lend till the find a suitable investment
avenue or they borrow in overnight market to manage liquidity for the next day.

Here, the bond matures the next business day, and the price will not be affected if the Reserve Bank
of India (RBI) changes the interest rates. The next day, bond matures and new overnight bonds are
purchased at the new price.

Even if the credit rating of the bond issuer changes, the bond price of this fund will not be affected
as it will mature the next day. Such funds are immune to interest rate risk and credit risk.These funds
carry lower maturity than typical Liquid Funds, so the returns of these funds will also be a bit lower.

Liquid Funds

 Liquid Fund is that category of mutual funds that invest in highly liquid instruments such as
treasury bills,government securities and call money market and CBLO.
 These funds can invest in instruments up to a maturity of 91 days. The maturity is mostly
much lower than that.
 They are least risky as well as least volatile in the category of mutual funds

Ultra Short term debt funds

 ultra short-term fund is also suitable for short-term investing.

 ultra-short-term funds invest in short-term instruments that have a maturity of over three
months.
 these are one notch higher on the risk chart compared with liquid funds. This is because
these instruments may also be traded in the market. Hence, the NAV may swing in response
to market movements, making it a little more volatile.

Low Duration Funds/Money market Funds

 Low duration fund: These open-ended debt schemes will invest in instruments with a
duration between six months and 12 months.
 Money market funds: A money market fund is a kind of mutual fund which invests only in
highly liquid cash and cash equivalent securities that have high credit ratings. These funds
 invest primarily in debt-based securities which have a short-term maturity of less than 13
months, and offer high liquidity with very low level of risk.

Short duration funds

These open-ended debt schemes will invest in instruments with a duration between one year and
three years. 

Medium duration funds

These open ended debt schemes will invest in instruments with a duration between three and four
years. 

Medium to Long Duration Fund

These mutual funds select bonds/debt for investment such that average maturity (remaining) period
for portfolio is between 4 to 7 years

Long duration fund

Bonds with maturities of close to seven to ten years are categorised as Long duration funds. They
yield more than shorter-term bonds and are less volatile than longer-term issues.

Gilt Fund with 10 year constant duration

These mutual funds invest mostlty in government bonds. They try to maintain portfolio such that
average remaining maturity (Macaulay duration) is 10 years. Government bonds are considered the
safest investment in the country,therefore their 80% of investment goes into g-secs.

These are the most actively traded bonds in NDS-OM (CCIL platform), CBOT (Chicago board of
trade),NSE – trading platforms for bonds in our country.

Dynamic Bond Fund

 Dynamic bond funds are debt mutual funds that alter allocations between short-term and long-term
bonds. This helps them take advantage of changing interest rates.

In an environment of rising interest rates, bond prices are generally falling. Again, this is because
bond investors don't want to buy bonds that pay lower interest rates unless they receive them at a
discount.

Furthermore, the longer the maturity, the larger the swing in price in relation to interest rate
movements. In a period of rising rates and declining prices, the long-term bond funds will decline in
value more than intermediate-term and short-term bonds. Therefore some investors and money
managers will shift their fixed income investments to shorter maturities when interest rates are
expected to rise. When interest rates are declining longer maturities (i.e. long-term bond funds) can
be a better bet.

Sometimes, there could be a long pause in between interest rate changes. This can take a hit on the
income of bond investors. Therefore, dynamic bond funds is an excellent alternative for those who
wish to play to the interest rate cycle.
The objective of a dynamic bond fund is to deliver ‘optimal’ returns in both rising and falling market
scenarios.

MATURITY

SHORT MEDIUM LONG

Overnight funds

Liquid funds

Ultra short term

Low duration

Short duration Medium duration Dynamic funds

Dynamic funds

Medium to long Long duration

duration

There are classifications on basis of credit quality of bonds

GILT Funds

These schemes will invest in government securities across maturity. These will invest a minimum 80
per cent of their total assets in government securities.Since g- secs have a risk free rate in domestic
market,they also act as a benchmarks for other securities.They represent general interest level in the
economy.GOI decides rate/coupon on these securities in their regular auctions held.

Corporate Bond Fund 

These schemes will predominantly invest in highest-rated corporate bonds. They should invest a
minimum 80 per cent of their total assets in the highest-rated corporate bonds.

A typical corporate bond fund would have REC,PFC,NHB,FDI,PGC,NABARD,Reliance Industries,Ultra

Tech Cement to name a few

Credit Risk Funds

These schemes will invest in below the highest-rated corporate bonds. These debt schemes
should invest a minimum of 65 per cent of their corpus in lower-rated corporate bonds.
So a typical credit risk fund would have papers with credit ratings ranging from AAA for safety to
AA+,AA,AA- and even A+ for generating return.So as we move lower on credit quality,higher yield we
get.

PSU and Banking Fund

These schemes will invest a minimum 80 per cent of their total assets in debt instruments of banks,
public sector undertakings and public financial institutions.

Floaters

These schemes will predominantly invest in floating rate instruments. They should invest a minimum
65 per cent of their total assets in floating rate instruments.

A floating rate fund invests in bonds and debtinstruments whose interest payments fluctuate with

an underlying interest ratelevel, as opposed to paying fixed-rate income
For. E.g. a bond could have a rate pegged to MIBOR such as MIBOR +100 bps

CREDIT QUALITY

High Medium Low

Gilt funds

Corporate Bond Credit Risk Funds Credit risk funds

funds

PSU and Banking

Fund

Floater Funds

Disclosure Norms

As per SEBI guidelines,AMCs are required to disclose performance of all schemes on AMFI website in
following manner:
 1. In case of all schemes,the scheme returns vis -a-vis the benchmark return (Total Return
Index) shall be disclosed in terms of CAGR for various periods viz 1 year,3 year,5 year,10 year
and since inception.
2. In addition to above,for schemes falling in actegories such as opvernight fund,liquid
fund,ultra short duration fund,low duration fund and money market fund,scheme
performance also to be disclosed for a period of 7 days,15 days,1 month,3 month and 6
month.
3. Disclosures to be made for all schemes and shall be updated daily based on previous day
NAV.
4. Disclosure should be made in investor friendly format with filters.
5. Disclosure should also include other important feature such as scheme AUM and previous
day NAV.

Expense Ratio

 Annual Fund Operating Expenses are known as the expense ratio. It is the percentage of
assets paid to administer, manage (including the auditor & advisor fees) and advertise or to
meet the other expenses of the mutual fund. ..
On 18 September 2018, SEBI brought about major modifications by reducing the expense
ratio of the mutual funds and changing the method of providing commission to the
distributors
 the maximum expense ratio that an  equity fund and debt fund could charge was 2.50% and
2.25% respectively.