Fixed income or Debt mutual funds primarily invest in a variety fixed income securities like treasury bills, commercial papers, certificates of deposits, corporate bonds and government bonds, issued by different banks, companies and the Government. The fixed income securities are of a range of maturity profiles from short maturity period of 3 months to long maturity periods of 30 years or more. The primary investment objective of short term debt mutual funds (short term maturity profile) is to generate income while that of long term debt funds (long term maturity profile) is to generate both income and capital appreciation. Unlike bank deposits, debt funds are not risk free investments.
There are two kinds of risk associated with debt funds:-
- Interest rate risk
- Credit risk
Long term debt funds have higher sensitivity to interest rate risks, while short term debt funds have lower sensitivity to interest rate risks. Corporate bond funds are exposed to credit risks. However, for the vast majority of debt mutual funds credit risk is quite low. Even the corporate bond funds, which aim to generate few percentage points of additional yield by investing in slightly lower rated corporate bonds, majority of the bonds in the fund portfolios are rated AAA and AA.