Best Debt Mutual Fund to Invest in for a Time Horizon of More Than 3 Years

Last Updated : July 13, 2020, 6:40 p.m.

Debt funds invest in debt securities such as corporate bonds, money market instruments, commercial paper, certificate of deposit, treasury bills and government securities. Different types of debt funds invest for varying maturities or duration of these securities. So, there could be a debt fund investing in securities maturing in a day, month, year, three years and more.

Your time horizon of investment plays an important part in selecting the right debt fund. There are different and appropriate debt funds for varying time horizons.

If you wish to invest for more than three years, we recommend investing on the basis of your risk appetite.

If you have a high risk appetite, you can invest in four types of debt funds- long term duration, medium duration debt funds, credit risk funds and gilt funds. These funds should deliver higher returns over the funds mentioned below with moderate and low risk.

If you have a moderate risk appetite, then three types of debt funds are suitable for you-dynamic bond funds, corporate bond funds and Banking & PSU debt funds. These funds should deliver 2-3% extra returns over the funds mentioned below.

Top Mutual Funds to Invest in Now

However, if your risk appetite is low and you want safety, we do not recommend investing in the above-mentioned funds. The most suitable type of debt funds for you are ultra-short, liquid and overnight funds. You can expect 4-6% annualized return from these funds.

You can invest in these funds by picking the best one or two funds in each category. We have also detailed the best funds in each category with links given below.

Best Debt Funds for More Than 3 Years with High Risk

Long Duration Debt Fund

Long term duration funds are open-ended debt funds that invest in debt securities with a duration between four to eight years. For simplicity, you can assume duration to be the time period in which the debt security will fully mature and return all coupons or interest payments.

The objective of these funds is to deliver better returns than low duration, short term duration and medium duration funds by taking a view on interest rate movements. Thus, these funds have a high interest rate risk, which is higher than the short term and medium duration funds.

To know about the best long duration debt funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-long-term-duration-debt-funds-to-invest-in/

Credit Risk Fund

A credit risk fund is a debt fund that invests in corporate bonds and commercial papers. The money you invest in a credit risk fund goes to the mutual fund company, which further lends it to corporates. What makes credit risk funds distinct is that a minimum 65% of the portfolio should be invested in lower rated corporate debt.

The rating of the bonds in a credit risk fund is below AA, the highest rating for a corporate bond is AAA. Companies with healthy balance sheets and good credit history have a higher rating. These ratings are reviewed regularly and changes are made basis the company’s financial performance. A company’s rating could be upgraded or downgraded based on its performance.

To know about the best credit risk funds, you can read another post of ours- Five Best Credit Risk Debt Funds to Invest in .

Medium Duration Debt Fund

Medium duration funds are open-ended debt funds that invest in debt securities with a duration between three to four years. For simplicity, you can assume duration to be the time period in which the debt security will fully mature and return all coupons or interest payments.

The objective of these funds is to deliver better returns than ultra-short, low duration and short term funds by taking a longer view on interest rate movements. Thus, these funds do have interest rate risk, which is higher than short term and low duration funds.

To know about the best medium duration debt funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-medium-term-duration-debt-funds-to-invest-in/

Gilt Funds

Gilt Funds or government securities funds are those funds that invest in bonds issued by the government of India. The government is the largest borrower in the Indian debt markets, it borrows money by issuing securities of various time periods. This is done to fund government expenditure on various things such as infrastructure, social spending, health, defence, education, etc.

Government securities are the highest rated bonds in the country since the government is the guarantor in this case. In the last one-year, gilt funds have been the best performing category of debt funds and most of these have delivered a double-digit return. In fact, these funds have also beaten all equity funds when it comes to returns.

To know about the best Gilt funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-gilt-funds-to-invest-in/

Best Debt Funds for More Than 3 Years with Moderate Risk

Banking and PSU Debt Funds

Banking and PSU funds are open-ended debt funds that invest at least 80% in debt securities of government banks, PSUs (public sector units) and government-owned/run financial institutions. All government-owned banks, PSU enterprises issue bonds and other debt securities in the debt market to raise funds. These securities are bought by mutual funds under this fund.

The objective of these funds is to deliver steady returns with a good quality portfolio. This portfolio is of good quality since all government banks and PSU enterprises have the best credit metrics and have a high credit rating, mostly AAA which is the highest rating for a corporate bond. Good credit quality means that these debt securities have the least probability of default.

To know about the best banking and PSU debt funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-banking-and-psu-debt-funds/

Corporate Bond Funds

Corporate bond funds are a category of debt funds that invest in bonds issued by corporates or companies. Corporates need capital to run their business and fuel their growth plans and resort to debt markets to raise such capital.

These funds have a high credit quality since 80% of the portfolio must be invested in companies with a rating of AA+ and they can invest up to 20% in securities with a rating below AA+. This makes these funds less risky when it comes to credit defaults, especially as compared to credit risk funds.

To know about the best corporate bond funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-corporate-bond-funds/

Dynamic Bond Funds

These funds are dynamically managed which means they have the flexibility to buy and sell debt securities of different maturities basis the view on interest rates. Factors such as inflation, growth and fiscal deficit determine the interest rates in an economy. When the economic growth is slow, interest rates are reduced to spur demand and vice versa.

Interest rates are inversely proportional to the bond prices, so when interest rates increase, bond prices decrease and when interest rates decrease, bond prices move up. During falling interest rates, these funds buy debt securities with higher maturities and increase weightage to gilts (government securities), and in an environment when interest rates are increasing, these funds invest in debt securities with shorter maturities.

To know the best dynamic bond funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-performing-dynamic-bond-funds-to-invest-in/

Best Debt Funds for More Than 3 Years with Low Risk

Ultra Short Term Funds

Ultra short term funds are a type of debt funds that invest in debt securities (corporate bonds, government securities and money market instruments) with an average maturity of 3-6 months. They are like liquid funds with the exception that liquid funds cannot invest in securities with maturities beyond 91 days.

Since these funds invest in securities with higher maturities, the risk and return are relatively higher than liquid funds. This is because interest rates do not fluctuate a lot in the short term, thereby having a lesser impact on the risk & returns of various debt funds. As the average maturity of a debt fund increases or is higher, interest rates have a bearing on the risk and return from that fund.

These funds are the best option for the next 6 months when we evaluate both risk and return expectations. To know the best ultra-short term funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-ultra-short-term-funds-to-invest-in/

Liquid Funds

Liquid funds are a type of debt fund that invests in treasury bills, commercial papers, bank fixed deposits. The maturities of all these in a liquid fund is up to 90 days. When you invest your money in a liquid fund, the same is lent by the mutual fund to institutions such as banks and corporates.

One can view these as an alternative to keeping money in a savings bank a/c where you get 3-4% whereas liquid funds tend to return 5-7%. There is no lock-in, one can withdraw anytime. There are no exit loads in liquid funds, so when one withdraws no amount is deducted by the AMC.

These funds are a safe option for the next 6 months with low risk but better returns than a savings bank account, to know the best liquid funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/5-best-performing-liquid-funds-to-invest-in/

Overnight Funds

Overnight funds are open-ended debt mutual funds that invest in securities with overnight or one-day maturities. These securities are treasury bills, certificate of deposits, commercial papers, floating rate debt instruments.

This implies that the fund manager buys these debt securities every day for a day and sells it the next day. He/she again buys these securities the next day, again for a day and this is how the portfolio is managed. Overnight funds do not invest in securities with a maturity profile of more than a day.

These funds are the safest option for the next 6 months. Returns will be marginally better than savings bank accounts. To know the best overnight funds, you can read another post of ours- https://www.wishfin.com/mutual-fund/five-best-overnight-debt-funds-to-invest-in/