Maturity and Liquidity in Debt Mutual Funds

Debt Funds are those Mutual Funds whose Portfolio has exposure to Corporate Bonds, Government Securities, Floating Rate Notes, Zero Coupon Bond, Commercial Papers, Treasury Bills and Certificate of Deposits which has different Maturity Periods (will mention with examples below).

Debt MFs are for those investors who would like to park their excess Money for certain period of time from 1 day to 3 Years which are less riskier and offers better returns than Bank Fixed Deposits (FDs) / Recurring Deposits (RDs).

Although there is no lock-in period in Debt MF schemes but there will be Exit Load (0.007% - 1%) if you withdraw before Maturity Period and Taxation based on period of holdings.

When comes Taxation in Debt Mutual Funds,

a)     Short-term Capital Gains (less than 3 years / 36 Months) – Taxed at Investors Tax Slab.

b)    Long-term Capital Gains (more than 36 Months) – Taxed at flat rate of 20% after Indexation + Applicable Cess + Surcharge.

The more long you keep your amount in Debt schemes, the higher and better will be the Returns.

So, what is Indexation?

   Indexation helps to prevent losing your returns on investments in the form of taxes which is applicable in long-term period.

Indexation rates are calculated using the Cost Inflation Index (CII). 

Cost Inflation Index (CII) is a figure issued by the Central Government every year that represents the year’s inflation which number keeps changing. 

If in a year, inflation was high, the CII number would be high and vice-versa.

For Example,

Mr. D invested Rs. 10,000 in a debt mutual fund scheme in September 2016 (FY 2016-17) at a NAV of 10.

After 3 years, in October 2020 (FY 2020-21) he redeemed his investments at a NAV of 20 and got Rs. 20,000.

So his capital gains were Rs. 10,000.

Since he held this investment for a period of more than 3 years, the gain on his investment is categorized as Long Term Capital Gain (LTCG) and he will get the benefit of indexation and doesn’t have to pay tax on entire Rs. 10,000.

In order to find the taxable gains after indexation benefit on Debt Fund returns, the original purchase price is adjusted for inflation using CII. The formula that is used is

Inflation-Adjusted Purchase Price = Actual Purchase Price X (CII in the year of sale/CII in the year of purchase)

The indexed cost of acquisition will be Rs.10, 947, i.e., (10,000 * 289/264).

Hence, instead of Rs.10, 000, your capital gains will now be Rs.9, 053, i.e. (Rs.20, 000 – Rs.10, 947).

Using indexation, you would have managed not to pay tax on Rs.947 of your gains. Your tax will be computed on only Rs.9, 053, which will be equal to Rs.1, 810.

Currently, Cost Inflation Index of 2021 – 22 is 317.

The benefit of indexation works best when your holding period is longer.

For a holding period of 5 years, long-term capital gains tax on debt funds can come down from 20% to 6-7%.

This is how indexation helps you in saving taxes on long-term capital gains from debt mutual funds and enhances your earnings.

Types of Debt Mutual Funds:

SEBI categorized Debt Funds into 15 types which have different Maturity Periods based on their Portfolio. Some of which are given below:

i)   Overnight Funds – 1 Day.

ii)   Liquid Funds – 91 Days.

iii)   Ultra-Short Duration Fund - 3 to 6 months (Macaulay duration).

iv)   Low Duration Fund - 6 to 12 months (Macaulay duration).

v)    Money Market Fund – 1 year.

vi)   Short Duration Fund - 1 to 3 years (Macaulay duration).

vii)   Medium Duration Fund - 3 to 4 years (Macaulay duration).

viii)  Medium to Long Duration Fund - 4 to 7 years (Macaulay duration).

ix)   Long Duration Fund - higher than 7 years (Macaulay duration).

x)  Dynamic Bond Fund - Maturity is adjusted based on market conditions to improve returns for the investors.

xi)    Gilt Fund – Invest in Government Bonds (much safer).

xii)  Corporate Bond Fund - highest rated bonds issued by corporates/companies. Invest money for longer duration but prefer less riskier assets compared to equity funds.

xiii)  Credit Risk Fund - Invest in bonds which are below highest grade rating. Higher the rating; Lower the possibility of default. However lower rated bonds offer higher interest rates, and thus returns. Invest money for longer duration but prefer less riskier assets compared to equity funds.

xiv)  Floater Fund - Invest in bonds which have floating interest rate. If interest rate goes up, then bond prices move down and reduce returns for the investors and vice a versa.

xv) Banking and PSU Fund:  Investing in Debt instruments of banks, Public Sector Undertakings, Public Financial Institutions.

Some Examples of Debt Funds Portfolio which have CRISIL and ICRA Ratings of AAA to A1+:

A) a)    CORPORATE BOND:

National Bank for Agriculture and Rural Development

Food Corporation of India (Guarantee from Government of India)

REC Limited

Small Industries Dev Bank of India

Indian Railway Finance Corporation Limited (IRFC)

Power Finance Corporation Limited (PFC)

Air India Assets Holding Limited

Aadhar Housing Finance Limited

Narmada Wind Energy Private Limited (NCDs backed by cashflows of operating renewable energy)

Pune Solapur (Corporate Guarantee by Tata Realty & Infrastructure Limited)

Housing Development Finance Corporation Limited (HDFC)

Embassy Office Parks REIT

India Grid Trust InvIT Fund

B)   b)  GOVERNMENT BOND:

8.13% GOI Oil Bonds (MD 16/10/2021)

7% Fertilizer Co SPL GOI 2022 (MD 10/12/2022)

8.83% GOI (MD 25/11/2023)

7.59% GOI (MD 11/01/2026)

4.7% GOI FRB (MD 22/09/2033)

6.64% GOI (MD 16/06/2035)

6.76% GOI (MD 22/02/2061)

C)   c)   STATE GOVERNMENT BOND:

8.51% Haryana SDL (MD 10/02/2026)

6.27% Rajasthan SDL (MD 20/07/2026)

6.82% Bihar SDL (MD 14/07/2028)

6.51% Karnataka SDL (MD 30/12/2030)

6.84% Gujarat SDL (MD 07/10/2030)

6.78% Maharashtra SDL (MD 25/05/2031)

6.97% Tamilnadu SDL (MD 28/07/2031)

8.69% Kerala SDL (MD 24/02/2026)

8.29% Andhra Pradesh SDL (MD 13/01/2026)

6.79% West Bengal SDL (MD 30/06/2028)

5.9% TELANGANA SDL (MD 27/05/2025)

d) TREASURY BILL:

91 Days Tbill

182 Days Tbill

364 Days Tbill

De)  COMMERCIAL PAPER:

Export Import Bank of India

Indian Oil Corporation Limited

NTPC Limited

L&T Finance Limited

Sikka Ports and Terminals Limited

Sharekhan BNP Paribas Financial Services Limited

Hindustan Zinc Limited

Cholamandalam Investment and Finance Company Limited

 

E    f) ZERO COUPON BOND:

LIC Housing Finance Limited

Tata Capital Financial Services Limited

TMF Holdings Limit

F)     g)  FLOATING RATE NOTE:

Mahindra & Mahindra Financial Services Limited

Varanasi Sangam Expressway Private Limited

      h) CERTIFICATE OF DEPOSIT:

IDFC First Bank Limited

        i) PTC

First Business Receivables Trust (PTC backed by receivables of service fees payment from RIL subs)