Debt Funds

Why in news?

Indian debt funds market reached record size recently.

What are debts and equities?

Debt instrument helps to raise loans by borrowing.
In return, the holder of debt instruments, are owed the amount of money borrowed along with the interest promised. e.g Bonds.
It involves less risk than equity investments and typically offers a correspondingly lower potential return on investment.
Equities also help to raise loans, but instead of owing back the money, partnership in the firm is offered based on the amount borrowed. e.g Shares.
It is riskier but has the potential to bring more returns if the firm makes profit.

What are debt funds?

Equity funds invest mostly in shares of listed companies and debt funds invest in instruments like government bonds, commercial papers (CPs), certificate of deposits (CDs) and non-convertible debentures (NCDs).
The interest made from these instruments is shared among the investors after deducting the fund-management charges.
The gains made on the investment in debt schemes are taxable.
If the securities are sold within 3 years, it is considered short-term wherein the gains are added to the income of the investor and taxed as per the applicable tax bracket.
If the securities are held for more than three years before selling, there are long-term capital gains tax.
The tax rate is 20% with indexation and 10% without indexation.

What are the different types of debt funds?

Debt funds can be classified on the basis of the tenure of the bonds or instruments in which they invest.

Liquid funds - They invest in instruments that have a tenure of less than 90 days.
Short-term funds - They invest in instruments that typically have a tenure of three to six months.
Corporate debt - They could have a tenure of up to three years.
Long-term funds - They invest in bonds that have a tenure of three to five years or even more e.g Government bonds (G-Secs).

What are the advantages?

They are generally used by banks and corporates for their treasury operations.
They offer more return than bank fixed deposits.
So they are popular among high net worth individuals (HNIs) to park their money temporarily before moving to other asset classes.
This enables the investors to indirectly invest in instruments like government bonds, where direct retail investment is not possible.
The risk is also higher compared to the safe FDs that offer assured returns so the number of retail investors in debt funds are still very little.
In the case of bonds, the price could fall due to various reasons thereby impacting its price and its return.
There have been cases where the securities have been downgraded that also led to less returns.

Quick Fact

Indexation

It refers to the mechanism wherein the gains are adjusted against the rate of inflation to derive the net taxable gains from the schemes.

Source: The Hindu