Written and edited by Nabhaneel Dutta, Rozgardesk, 7th Nov 2025

The Debt Fund Universe: Understanding Risk and Duration

Debt mutual funds are the foundation of a stable investment portfolio, offering returns generally superior to traditional savings accounts while aiming for capital preservation. However, not all debt funds are created equal. Their risk levels are primarily defined by two crucial factors:

• Credit Risk: The possibility that the issuer of a bond (a company or government) may default on interest or principal payments. Higher credit risk usually means higher potential returns.
• Interest Rate Risk (or Duration Risk): The sensitivity of a bond's price to changes in market interest rates. The longer the maturity (duration) of the bond, the higher this risk. When interest rates rise, bond prices fall, and vice-versa.

🔺 Very High Risk Debt Funds

1. Credit Risk Fund ⚠

Concept: These funds deliberately invest a significant portion of their assets (at least 65%) in bonds rated below AA. They take on high credit risk in pursuit of higher yields (interest income) that lower-rated bonds typically offer.

Risk Profile: Highest Credit Risk. The fund's performance is highly dependent on the ability of the low-rated issuers to meet their debt obligations. If a single issuer defaults or is downgraded, the fund’s Net Asset Value (NAV) can drop sharply. They are relatively less exposed to interest rate risk if they stick to shorter-duration papers.

Investor Suitability: Aggressive debt investors with a minimum 3-5 year horizon who are comfortable with potential volatility and have the expertise to track the credit market.

2. Long Duration Fund ⚠

Concept: These funds must invest in bonds where the Macaulay Duration of the portfolio is greater than seven years. This means they primarily hold long-term government or high-rated corporate bonds.

Risk Profile: Highest Interest Rate Risk. Since bond prices and interest rates move inversely, a minor change in the interest rate outlook can cause a dramatic fluctuation in the fund’s NAV. They are excellent when rates are falling but suffer significantly when rates rise. Credit risk is usually low if they stick to high-quality issuers (e.g., G-Secs).

Investor Suitability: Investors with a very long-term horizon (5+ years) who have a strong conviction that interest rates will fall or are already low, seeking high capital appreciation.

3. Dynamic Bond Fund ⚠

Concept: The fund manager has the freedom to dynamically manage the portfolio's duration (maturity profile) and credit quality based on their outlook of the interest rate cycle and economic conditions. They can switch completely from short-term to long-term bonds.

Risk Profile: High Management Risk. The risk is tied directly to the fund manager's ability to predict interest rate movements correctly. A wrong call on the direction of interest rates can lead to substantial losses, making them highly volatile despite their 'dynamic' nature.

Investor Suitability: Investors with a high-risk appetite and faith in the fund manager’s expertise, looking for capital appreciation across interest rate cycles. Suitable for a 3-5 year horizon.

🔸 High to Moderate Risk Debt Funds

4. Corporate Bond Fund 💼

Concept: These funds must invest at least 80% of their total assets in corporate bonds with the highest credit ratings (AA+ and above). This focus ensures the portfolio maintains high credit quality.

Risk Profile: Moderate Credit Risk. While the focus is on high-rated bonds, corporate bonds still carry some inherent credit risk, unlike government bonds. Their duration (interest rate risk) is usually medium, making them less volatile than Long Duration Funds.

Investor Suitability: Investors seeking stable, inflation-beating returns over a 3-year plus horizon who prefer the safety of highly-rated companies but want a slightly better return than Gilt Funds.

5. Gilt Fund (Long-Term) 🏦

Concept: Gilt funds invest at least 80% of their assets in Government Securities (G-Secs) issued by the Central or State Governments. They can hold securities of varying maturities.

Risk Profile: Virtually No Credit Risk. Since they invest in government-backed securities, the risk of default is negligible. However, if the fund manager chooses to invest in long-term G-Secs, the fund is exposed to High Interest Rate Risk, similar to Long Duration Funds. Short-term Gilt Funds exist, but most carry medium-to-long duration.

Investor Suitability: Those with a 3-5 year horizon who prioritize credit safety above all else but are willing to tolerate the significant short-term volatility caused by interest rate movements.

6. Medium Duration Fund 📅

Concept: These funds must maintain a Macaulay Duration between 3 and 4 years. This places them squarely in the medium-term maturity bracket.

Risk Profile: Moderate Interest Rate Risk. They are designed to manage volatility by avoiding both the extreme short-term stability of liquid funds and the high interest rate sensitivity of long-term funds. Credit risk depends on the underlying quality of the papers held.

Investor Suitability: Investors with an investment horizon matching the fund's duration (3-4 years) seeking a balance between risk and potential returns.

7. Banking & PSU Fund 🏦

Concept: Must invest a minimum of 80% of their total assets in debt instruments issued by Banks, Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), and Municipal Bonds.

Risk Profile: Low to Moderate Credit Risk. Since PSUs and major banks are often government-backed or systemically important, the credit risk is generally low, making them highly favored for safety. They carry moderate interest rate risk, depending on the duration of their holdings.

Investor Suitability: Conservative investors with a 2-3 year horizon who prioritize capital safety and are satisfied with moderate returns.

🟡 Moderate to Low Risk Debt Funds

8. Short Duration Fund ⏳

Concept: Mandated to maintain a Macaulay Duration between 1 and 3 years. These funds invest in instruments like Commercial Papers (CPs) and Certificates of Deposit (CDs).

Risk Profile: Low Interest Rate Risk. The shorter duration makes them less susceptible to interest rate volatility compared to medium or long-duration funds. They offer better stability and are a good choice for managing money required in the near future.

Investor Suitability: Investors with a 1 to 3-year horizon seeking better returns than ultra-short funds without taking on major interest rate risk.

9. Money Market Fund 💰

Concept: These funds invest solely in money market instruments (like T-Bills, CPs, CDs) with a maximum maturity of up to 1 year.

Risk Profile: Very Low Volatility. Due to the 1-year ceiling on maturity, both interest rate risk and volatility are significantly limited. They aim for stability and capital protection.

Investor Suitability: Individuals or corporations looking to park surplus cash for 6-12 months for liquidity and marginally higher returns than bank deposits.

10. Floater Fund 🔄

Concept: These funds must invest at least 65% of their total assets in floating rate debt instruments, where the interest rate paid on the bond adjusts periodically based on a benchmark (e.g., the Repo Rate).

Risk Profile: Minimizes Interest Rate Risk. Since the coupon (interest) rate adjusts with the market, the price of the bond remains relatively stable, shielding the fund from rising interest rates. The primary risk is the credit quality of the underlying floating rate bonds.

Investor Suitability: Ideal for investors when interest rates are expected to rise or are already high, or for those seeking to minimize interest rate risk in their portfolio.

🟢 Low to Very Low Risk Debt Funds

11. Low Duration Fund ✅

Concept: These funds must maintain a Macaulay Duration between 6 months and 12 months. This is a step up in maturity from Ultra Short Duration Funds.

Risk Profile: Very Low Interest Rate Risk. The short duration ensures minimal price volatility due to interest rate changes. They provide better returns than liquid funds by taking slightly more duration risk.

Investor Suitability: Parking funds for short-term goals (6–12 months) where stability and low volatility are key requirements.

12. Ultra Short Duration Fund ✅

Concept: The Macaulay Duration of the portfolio is between 3 months and 6 months. They invest in short-term instruments to provide high liquidity and stable returns.

Risk Profile: Extremely Low Interest Rate Risk. They are marginally more volatile than liquid funds due to the slightly longer maturity, but still highly stable and ideal for managing emergency funds or money needed in a few months.

Investor Suitability: Suitable for investors with a horizon of 3-6 months, often used as a better alternative to keeping money in a savings bank account.

13. Liquid Fund 💧

Concept: Liquid funds invest only in debt and money market instruments with maturities of up to 91 days.

Risk Profile: Minimum Volatility. Their instruments have extremely short maturity, making them highly insensitive to interest rate changes. They offer very high liquidity, with rules allowing for partial redemption proceeds to be credited within a few hours.

Investor Suitability: The best choice for parking emergency funds