A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
What are the effects on the performance of debt funds?
Debt funds invest our money in interest-bearing securities such as bonds and money market instruments that promise to pay regular interest. These interest payments are received by the fund, which in turn contributes to the total return that we, as investors of the fund, earn. When interest rates change in the market, the prices of fixed-income securities such as bonds and money market instruments also change, but in the opposite direction. When interest rates rise, the prices of these assets fall and vice versa. Therefore, the NAVs of debt funds change with the change in the prices of these securities. Changes in NAV affect the total return generated by these funds.
In addition to changes in interest rates, changes in the credit rating of bonds can have an impact on debt fund returns. Credit ratings indicate the creditworthiness of bond issuers. A rating downgrade will lower the prices of these bonds. This, in turn, will cause downward pressure on the NAVs of the funds holding these bonds. Therefore, a credit downgrade of bonds held in a Deb fund’s portfolio can reduce returns.
The increased risk of default or the chances that the bond issuer will not pay interest or return on principal adversely affects the returns of debt funds since interest payments add to the total return from debt funds since interest payments add to the total return from the fund.