The Best Debt Funds to Invest in 2023

What are Debt Funds?

Debt Mutual funds invest in fixed-income securities such as corporate bonds, government securities, money market instruments, etc.

These funds are also known as income funds or bond funds. The difference between the purchase price and the selling price of the securities adds to the NAV of the fund.

If the fund bought security for Rs 1000 and had to sell it in extreme market conditions at Rs 900 by making a loss, it would result in the depreciation of the NAV.

How do debt funds make money?

Debt funds earn through capital appreciation and interest income from fixed-income securities. Consider that a debt fund receives 10% interest per annum; this is divided by 365 and is added to the NAV every day.

A debt fund’s NAV hence depends upon the interest rate and the credit rating of its portfolio. If the credit rating of one of the securities that a fund is invested into goes down (due to default), the NAV of the fund also depreciates.

The interest rate regime also has an effect on the NAV of the fund. For example, if a fund ABC holds security that offers 8% interest. If the RBI announces a decrease in the interest rates, then any new security would adhere to these new regulations and offer a lower interest rate.

This would drive up the demand for pre-existing securities which were offering a higher rate (similar to our security which offered a rate of 8%). Consequently, the price of these bonds/securities would increase, leading to an increase in the NAV of the fund.

Types of Debt Funds

In the following paragraphs, we aim to provide 2 top-performing funds in each of the debt fund categories and also aim to provide insights on which category would be ideal for you.

1. Liquid & Money Market Funds

These funds invest in money market securities with a maturity lower than 91 days. They are considered to be a good alternative to savings accounts and fixed deposits as they offer higher returns and are tax-friendly (when compared to traditional instruments).

They have a reasonable level of safety of the invested principal, coupled with liquidity. They typically do not have exit loads.

Investor

If you have surplus cash or a sudden influx of money – sale of real estate property, bonus, or something similar, instead of parking it in a savings account and earning a meager 4% return, you could consider Liquid funds as an alternative.

These are also suitable for risk-averse investors and for investors looking for stable returns and liquidity.

Scheme Name	1-year Return	AUM	Pros	Cons
Quant Liquid Fund	4.85%	Rs 174.84 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average. The age of the fund is greater than 3 years.	A high expense ratio of 0.62% (could potentially dent your earnings). AUM is less than Rs 1000 Cr, where investors need to keep an eye on the expense ratio as the fees for the operation of the fund are collected from a small base of investors.
IDBI Liquid Fund		Rs 1114.21 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average. The age of the fund is greater than 3 years. The expense ratio is on the lower end – 0.13%.	AUM is slightly higher than Rs 1000 Cr, where investors need to keep an eye on the expense ratio as the fees for the operation of the fund are collected from a small base of investors.

2. Gilt Funds

Gilt funds invest in Government securities of State and Central governments with different bond tenures (or varying maturities) such as 1-year, 3-year, 10-year, etc.

Government bonds are considered to be risk-free and have a zero probability of default (Credit risk is zero).

However, these funds are subject to interest rate risk i.e., the portfolio’s worth appreciates or depreciates depending on the interest rate regime in the economy.

Investor

These are suitable for a risk-averse investor. They are beneficial in a falling interest rate environment as these funds would have underlying securities which would carry a high coupon.

Scheme Name	1-year Return	AUM	Pros	Cons
ICICI Prudential Gilt Fund Expense Ratio: 0.61% Min SIP Amount: Rs 1000	11.12%	Rs 4,086.85Cr	Have higher 1-year, 3-year, and 5-year returns than the category average Exit Load is Zero	None
DSP Government Securities Fund Expense Ratio: 0.54% Min SIP Amount: Rs 500	10.36%	Rs 444.52 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average Exit Load is Zero	None
Edelweiss Government Securities Fund Expense Ratio: 0.41% Min SIP Amount: Rs 500	12.07%	Rs 88.68 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average Exit Load is Zero	AUM is slightly higher than Rs 100 Cr, where investors need to keep an eye on the expense ratio as the fees for the operation of the fund is collected from a small base of investors.

3. Short-Term Funds

Funds that invest in securities that have a maturity of 1-3 years with high liquidity. The fund invests in corporate bonds, certificates of deposit, commercial paper, and government securities with medium and long-term maturities.

They are prone to a lower interest rate risk when compared to medium and long-term funds. This aids the funds to sail through adverse market conditions.

Investor

They are ideal for risk-averse investors who aim to receive higher post-tax interest or returns (when compared to FDs). When the investment horizon is greater than 1 year.

Scheme Name	1-year Return	AUM	Pros	Cons
Aditya Birla Sun Life Short-Term Fund Expense Ratio: 0.39% Min SIP Amount: Rs 100	12.00%	Rs 7,001.71 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average. Exit Load is Zero The expense ratio is on the lower end	None
ICICI Prudential Short-Term Fund  Expense Ratio: 0.44% Min SIP Amount: Rs 100	10.92%	Rs 22,254.84 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average Exit Load is Zero The expense ratio is on the lower end	The AUM of the fund is greater than Rs 20,000 Cr. After crossing this benchmark, the returns of the fund tend to be stagnated or experience a downturn

4. Medium-Term Funds

Funds that invest in securities that have a medium-term maturity of 3-4 years. SEBI mandates that these funds invest in securities that have a Macaulay duration of 3-4 years.

They earn higher post-tax returns when compared to a 5-year bank FD. One can also choose to opt for monthly income plans if one wishes to receive a periodic income from their investments.

Investor

They are ideal for risk-averse investors who aim to receive higher post-tax interest or returns (when compared to FDs). They are also ideal for the diversification of risk.

They are less volatile when compared to equity funds and are also less prone to interest rate risk when compared to long-term funds. 

Scheme Name	1-year Return	AUM	Pros	Cons
SBI Magnum Medium Duration Fund Expense Ratio: 0.68% Min SIP Amount: Rs 500	10.88%	Rs 8,505.15 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average	None
ICICI Prudential Medium Term Bond Fund Expense Ratio: 0.73% Min SIP Amount: Rs 1000	11.12%	Rs 6,437.31 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average	None

5. Dynamic Bond Funds

Funds are actively managed or employ a dynamic investment/asset allocation strategy by reducing the average portfolio duration (or maturity) in increasing interest rate environments and increasing the duration in a falling interest rate regime. These funds hence provide an option to the investor to earn from the interest rate fluctuations.

Investor

They are suitable for investors who would like to stay invested for the long term without worrying about the interest rate movements affecting their wealth creation.  

Scheme Name	1-year Return	AUM	Pros	Cons
Axis Dynamic Bond Expense Ratio: 0.25% Min SIP Amount: Rs 1000	10.88%	Rs 8,505.15 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average Exit Load is zero The expense ratio is on the lower end	None
Kotak Dynamic Bond Fund Expense Ratio: 0.47% Min SIP Amount: Rs 1000	11.12%	Rs 6,437.31 Cr	Have higher 1-year, 3-year, and 5-year return than the category average Exit Load is zero The expense ratio is on the lower end	None

6. Credit risk funds

These funds allocate 65% of their total assets for the purchase of lower-rated securities (lower than AA- credit rating) and offer higher returns to their investors. The credit risk is higher for these funds.

The interest rate risk is comparatively lower as these funds invest in securities with low maturities. The funds also gain from capital appreciation if the underlying security is upgraded to a higher credit rating.

Investors

These are only suitable for investors who are willing to take a higher risk. This is due to the lower credit securities as a part of the portfolio which have a higher probability of default.

Scheme Name	1-year Return	AUM	Pros	Cons
ICICI Prudential Credit Risk Fund Expense Ratio: 0.90% Min SIP Amount: Rs 1000	10.01%	Rs 7,209.19 Cr	Have higher 1-year, 3-year, and 5-year returns than the category average	None
HDFC Credit Risk Debt Fund Expense Ratio: 1.06% Min SIP Amount: Rs 500	11.25%	Rs 7,315.34Cr	Have higher 1-year, 3-year, and 5-year returns than the category average	The expense ratio is on the higher end

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