A Detailed Look at Debt Mutual Funds and their Categorization

Introduction Mutual fund investors often seek clarity and consistency. But with fund houses offering multiple overlapping debt schemes, confusion was common. Recognizing this, SEBI (Securities and Exchange Board of India) issued a circular on October 6, 2017, introducing a uniform classification and rationalization system for all mutual fund schemes.

This blog unpacks debt fund categorization under that framework—why it matters, what changed, and how it helps you as an investor.

What are Debt Mutual Funds

Debt mutual funds invest in fixed-income securities like:

• Government securities (G-Secs)

• Treasury bills (T-Bills)

• Corporate bonds

• Commercial paper

• Bank CDs

• Money market instruments

They are low- to moderate-risk, SEBI-regulated, and diversified by design—ideal for entities that want capital preservation, liquidity, and better-than-bank returns.

🧠 Key Benefits Over Traditional Instruments

1. Better Returns Than Current Accounts or Sweep FDs

Current accounts earn zero. Sweep FDs barely beat inflation.Debt funds—especially liquid, money market, or ultra-short duration—can generate 5–7% annualized returns with low volatility.

2. High Liquidity Without Lock-In

• No pre-closure penalty like FDs.

• Redemptions in T+1 or T+3 days.

• You can withdraw partial amounts as needed, unlike FDs that require premature closure of the full sum.

3. Efficient Treasury Management

• No need to split into multiple fixed deposits for laddering.

• One single fund can be used to match short-, mid-, and long-term outflows.

• NAV-based valuation helps bring transparency and real-time visibility into holdings.

4. Tax Deferral Advantage

• Unlike FDs, where interest is taxed every year, debt fund capital gains are taxed only when redeemed.

• This deferral helps with cash flow and working capital efficiency.

5. Accounting and Audit-Friendly

• Daily NAV ensures mark-to-market compliance.

• Works well with modern accounting and audit standards.

• Professional fund houses provide regular statements, summaries, and audit-ready documentation.

Why SEBI Standardized Debt Fund Categories

Before 2017, fund houses had too much flexibility in naming and structuring debt funds. Similar schemes with slightly different names made it difficult for investors to make informed choices. SEBI's goal was to:

• Ensure clear differentiation between schemes.

• Enable fair comparisons across AMCs.

• Improve transparency in scheme objectives and strategies.

• Protect investor interest by avoiding duplication and marketing gimmicks.

SEBI mandated that each AMC can have only one scheme per debt category, with a few exceptions (like ETFs and thematic funds).

The Official SEBI Debt Fund Categories

SEBI classified debt funds into 16 categories, grouped by investment duration, credit quality, and strategy. Here's a deep dive:

I. Duration-Based Debt Funds These are classified based on the Macaulay duration (Macaulay Duration is the weighted average time it takes to receive all cash flows (interest and principal) from a bond or debt instrument). of the portfolio — a weighted average term to maturity of the cash flows.

Category	Portfolio Requirement
Overnight Fund	Invests in overnight securities (1-day maturity)
Liquid Fund	Debt and money market instruments with maturity up to 91 days
Ultra Short Duration Fund	Macaulay duration: 3–6 months
Low Duration Fund	Macaulay duration: 6–12 months
Money Market Fund	Money market instruments with maturity up to 1 year
Short Duration Fund	Macaulay duration: 1–3 years
Medium Duration Fund	Macaulay duration: 3–4 years
Medium to Long Duration	Macaulay duration: 4–7 years
Long Duration Fund	Macaulay duration: >7 years
Dynamic Bond Fund	No fixed duration; dynamic allocation based on interest rate outlook

Why this matters: Duration directly affects interest rate risk. Short-term funds are less sensitive to rate changes, while long-term funds offer potentially higher returns but with higher risk.

II. Credit Quality & Issuer-Based Funds

These focus on the credit profile of the instruments in the portfolio.

Category	Portfolio Requirement
Corporate Bond Fund	Minimum 80% in highest-rated corporate bonds
Credit Risk Fund	Minimum 65% in below-highest-rated corporate bonds
Banking and PSU Fund	Minimum 80% in debt instruments of banks, PSUs, and PFIs

Key point: Credit Risk Funds offer higher yields but carry more default risk, while Corporate Bond and PSU Funds prioritize safety and quality.

III. Strategy or Instrument-Based Funds

These are driven by specific investment strategies or instruments.

Category	Portfolio Requirement
Gilt Fund	Minimum 80% in government securities across maturity
Gilt Fund with 10-Year Constant Duration	Minimum 80% in G-secs with fixed 10-year maturity
Floater Fund	Minimum 65% in floating rate instruments

These are ideal for investors with specific risk-return preferences—like low credit risk (gilt) or interest rate protection (floater).

Additional Rules from the SEBI Circular

• Mutual funds must update scheme documents to reflect these standardized categories.

• "Type of Scheme" labels used in brochures and ads must match SEBI's definitions.

• Portfolios must be rebalanced within one month of AMFI’s updated stock list (applicable to equity schemes, but part of the same circular).

• Existing schemes not aligned to the new structure had to be merged, wound up, or repositioned.

How to Use This Classification as an Investor

This structure isn't just regulatory—it’s practical. It helps you match funds with your financial needs:

Investment Goal	Fund Type
Parking surplus money for a few days	Overnight / Liquid Fund
Need liquidity with slightly better returns	Ultra Short / Low Duration Fund
Investment horizon of 1–3 years	Short / Medium Duration Fund
Long-term debt investment	Long Duration / Dynamic Bond / Gilt Fund
Stable income from high-quality issuers	Corporate Bond / Banking & PSU Fund
Willing to take more risk for extra yield	Credit Risk Fund

The Bottom Line

SEBI’s categorization of debt mutual funds brought much-needed clarity and discipline to the mutual fund space. Investors can now compare funds confidently, knowing each category follows a standardized rulebook.

Choosing the right fund isn’t about chasing returns—it’s about matching your goals with the fund’s structure and strategy. With this framework in place, making that match has never been easier.

VR Financial Services, based in Bengaluru and founded in 2019, is a full-service financial product distribution company. We empower individuals, families, businesses, and trusts to manage their finances with clarity and confidence.

We offer:

• End-to-end investment solutions across mutual funds, NPS, FDs, and more

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Our approach is data-driven, goal-oriented, and designed to evolve with changing market dynamics. At VR Finserv, we help you navigate risk and build a more secure financial future.

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Disclaimer

Mutual Fund investments are subject to market risks. Please read all scheme-related documents carefully before investing. The information provided herein is intended solely for educational and informational purposes and should not be construed as investment advice, a recommendation, or an offer to buy or sell any securities or financial products. Past performance is not indicative of future results. Investors are strongly advised to conduct their own due diligence and consult with certified financial advisors before making any investment decisions. Ensure your KYC compliance is completed through SEBI-registered intermediaries only. VR Financial Services does not guarantee any returns and does not offer fixed or assured return schemes—any such claims are misleading and prohibited by SEBI. All investment transactions must be carried out through official channels; do not share personal credentials or OTPs with anyone. We do not solicit funds or investment commitments through social media platforms, which are used strictly for educational outreach and investor awareness.