Debt mutual funds are often sold as an alternative to bank fixed deposits. But they are not entirely risk-free. Though debt funds may not be as risky as equity funds, they do come with the possibility of capital erosion.
Over the past 12-15 months, a spate of corporate bond downgrades and defaults have impacted the performance of debt mutual funds. Bonds issued by IL&FS, DHFL, Essel Group and Reliance ADAG Group were all been downgraded sharply. This led mutual fund companies marking down such distressed assets in the portfolio of the schemes that held them. Many debt funds, including liquid funds, witnessed a significant drop in their NAV (net asset value).
Given that the credit quality issue in debt instruments has been persisting for some time, investors can consider debt fund categories that focus on high credit quality, short-to-medium maturities and inherent high liquidity. These include overnight funds, liquid funds, money market funds, corporate bond funds, and banking and PSU debt funds.
Investors can choose debt schemes which have diversified allocation to different types of debt instruments. Such diversification offers liquidity while mitigating credit risk.
Overnight funds
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