A debt fund is a mutual fund that lends rather than owns — it holds government securities, treasury bills, corporate bonds and money market instruments instead of shares. Its return comes from the interest those instruments pay plus the movement in their prices, which is why it is not the fixed, guaranteed outcome of a bank deposit. SEBI’s scheme categorisation splits debt funds into sixteen categories, largely by how long the securities they hold take to mature.

difference between credit risk and duration risk in a debt fund

Credit risk is a borrower in the portfolio failing to pay; duration risk is existing bonds losing value because interest rates rose. The distinction matters because the losses behave differently — a duration loss reverses as bonds mature and the money rolls into higher-yielding paper, while a default is usually permanent and tends to arrive without warning. The serious accidents in Indian debt funds have been credit events, not rate events.

a debt fund investing in instruments maturing within 91 days is called a

A liquid fund. SEBI’s categorisation restricts liquid funds to debt and money market securities with a residual maturity of up to 91 days, which keeps duration risk close to zero. That very short maturity is why liquid funds, and overnight funds below them, are the categories matched to money needed within days or weeks rather than years.

why does one debt fund show a higher yield to maturity than another

Usually because it holds lower-rated paper. Yield to maturity is what the current portfolio would return if every borrower paid in full and the bonds were held to maturity, so a noticeably higher YTM on similar maturities is compensation for higher default risk rather than evidence of a better manager. The monthly factsheet lists the portfolio with its credit ratings, which is where that question gets settled in about ninety seconds.

how are debt mutual funds taxed in india now

For units bought on or after 1 April 2023, gains on most debt funds are added to your income and taxed at your slab rate regardless of how long you held them, and the older long-term treatment with indexation no longer applies to them. Units purchased before that date fall under the earlier rules, so the purchase date matters when you redeem. What debt funds still offer over a deposit is liquidity and control over timing, because tax falls only when you redeem rather than on interest credited each year.

Debt funds: credit risk, duration and the tax change

Debt funds are sold as "safe" and treated as an FD with better returns. They are neither. They carry two distinct risks that behave very differently, and knowing which one a fund is taking is most of what you need.

The two risks

What can actually go wrong

Credit risk

A borrower in the portfolio fails to pay
Losses are sudden and can be permanent
Higher yields usually mean higher credit risk
The risk that has caused real Indian blow-ups

Duration (interest rate) risk

Rates rise, so existing bonds are worth less
Losses are temporary if you hold long enough
Longer maturity means bigger swings
Uncomfortable but usually recoverable

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Raise the rate and watch the price of a longer bond fall further than a shorter one. That sensitivity is duration, and it is the risk you can actually see coming.

Matching the fund to the horizon

Money needed in	Suitable category	Why
Days	Overnight / liquid	Near-zero duration, minimal credit risk
3–12 months	Ultra-short / money market	Slightly more yield, still short
1–3 years	Short duration / corporate bond	Some rate sensitivity, manageable
3+ years, rate view	Medium to long duration / gilt	Real swings; only with a view and patience
Any horizon, safety first	Gilt or PSU-heavy funds	Government or quasi-sovereign credit

The tax change and what it did

Debt fund gains were once taxed at long-term rates with indexation after three years, which made them clearly better than fixed deposits for longer horizons. Since April 2023, gains on most debt funds are taxed at your slab rate regardless of holding period.

Worked example

What the change removed

A 30% slab investor, 7% return, 4 years

Old treatmentEffective tax often in low single digitsLong-term with indexation

New treatmentPost-tax return roughly 4.9%Slab rate, 30%

Versus a fixed depositThe tax advantage that justified debt funds is goneNow similar

What still favours debt fundsNo lock-in, and tax only on redemption rather than annuallyLiquidity and deferral

Debt funds are no longer clearly better than deposits on tax. They remain better on liquidity and on the timing of tax — you choose when to realise the gain — which matters more for large sums than small ones.

Check yourself

Two debt funds hold similar maturities, but one shows a yield to maturity two percentage points higher. What is the most likely explanation?

Simple bhasha mein

Do alag khatre, ek jaisa naam

Debt fund ko log FD ka bhai samajh lete hain. Usme do alag khatre hain: rate badhne se bhaav girta hai — woh waqt ke saath wapas aa jaata hai. Aur koi udhaar lene wala default kar de — woh paisa wapas nahi aata. Jyada yield dikhe toh samajh lo doosra wala khatra hai.

What to remember

Debt funds carry credit risk and duration risk, and they behave completely differently.
Duration losses reverse with time; credit losses are usually permanent.
Match the category to your horizon — liquid for days, short duration for a year or two.
A noticeably higher yield to maturity means weaker credit, not better management.
Since 2023 most debt fund gains are taxed at slab rate, removing the old advantage over deposits.

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Common questions

Short, direct answers to what people ask about this topic.

debt fund meaning: A debt fund is a mutual fund that lends rather than owns — it holds government securities, treasury bills, corporate bonds and money market instruments instead of shares. Its return comes from the interest those instruments pay plus the movement in their prices, which is why it is not the fixed, guaranteed outcome of a bank deposit. SEBI’s scheme categorisation splits debt funds into sixteen categories, largely by how long the securities they hold take to mature.
difference between credit risk and duration risk in a debt fund: Credit risk is a borrower in the portfolio failing to pay; duration risk is existing bonds losing value because interest rates rose. The distinction matters because the losses behave differently — a duration loss reverses as bonds mature and the money rolls into higher-yielding paper, while a default is usually permanent and tends to arrive without warning. The serious accidents in Indian debt funds have been credit events, not rate events.
a debt fund investing in instruments maturing within 91 days is called a: A liquid fund. SEBI’s categorisation restricts liquid funds to debt and money market securities with a residual maturity of up to 91 days, which keeps duration risk close to zero. That very short maturity is why liquid funds, and overnight funds below them, are the categories matched to money needed within days or weeks rather than years.
why does one debt fund show a higher yield to maturity than another: Usually because it holds lower-rated paper. Yield to maturity is what the current portfolio would return if every borrower paid in full and the bonds were held to maturity, so a noticeably higher YTM on similar maturities is compensation for higher default risk rather than evidence of a better manager. The monthly factsheet lists the portfolio with its credit ratings, which is where that question gets settled in about ninety seconds.
how are debt mutual funds taxed in india now: For units bought on or after 1 April 2023, gains on most debt funds are added to your income and taxed at your slab rate regardless of how long you held them, and the older long-term treatment with indexation no longer applies to them. Units purchased before that date fall under the earlier rules, so the purchase date matters when you redeem. What debt funds still offer over a deposit is liquidity and control over timing, because tax falls only when you redeem rather than on interest credited each year.