| Debt funds | Portfolio Allocation | Advantages | Drawbacks | Risk-return profile | Suitability for investors | Preferred investment duration |
| Liquid funds | These funds invest 100% in money market instruments, a large portion being invested in call money market. | They offer a high degree of safety as well as quick maturity. Not only do liquid funds offer higher returns than bank deposits, there's no tax deduction at source (TDS) on them, unlike bank deposits. | They, however, give the lowest of returns among all the classes of mutual funds. | They offer the lowest return and have the lowest risk involved. | They are suitable for highly risk averse investors who want to park their surplus for a short period of time. | Investment duration in liquid funds should be short term, 1-3 months. |
| Gilt funds ST | They invest 100% of their portfolio in government securities of and T-bills. | Level of risk associated is very low. Advantageous to invest in short term gilt fund when the interest rates are likely to go up. | Return potential is very low. Investing in long term gilt funds when the interest rates are predicted to fall could give poor returns. | Since they invest in government securities and T-bills, negligible credit risk is associated with them. They lie in low risk-low return category. | Good for conservative investors who would like to avail the benefits of capital safety with government security. | Investment duration could be short or long. It is advisable to invest in short term gilt funds when the interest rates are predicted to go up. |
| Floating rate funds/ short-term income funds | Invest in short-term debt papers. Floaters invest in debt instruments which have variable coupon rate | Apt avenue during rising interest scenario, as interest rate risk is minimal | Typically, returns on such funds are lower than long-term funds when interest rates are falling | Interest rate risk is very low | Suitable for highly conservative investors | Investment duration could be short, medium or long. Long term implies duration of greater than 1 year. Medium term is a period of 6 months- 1 year. Short term is considered as 1-3 months. |
| Arbitrage funds | They generate income through arbitrage opportunities due to mis-pricing between cash market and derivatives market. Funds are allocated to equities, derivatives and money markets. Higher proportion (around 75%) is put in money markets, in the absence of arbitrage opportunities. | Due to the usage of arbitrage strategy, equity risk is negligible. Hence they can deliver superior risk-adjusted returns than other short term debt funds. | Attractive arbitrage opportunities may not occur always. Assets are therefore allocated to money markets. This lowers the return potential. Some funds do not offer the facility of redeeming units on any working day, thus reducing the liquidity associated with the fund. | These funds are less risky than MIPs since their exposure in equities is hedged. | Suitable for conservative investors who would like to avail better returns than debt funds. | Suitable for short as well as long term investment. Some funds charge exit loads if redeemed before a specific period. This factor should be considered before making an investment in a fund. |
| Gilt funds LT | They invest 100% of their portfolio in long-term government securities | Level of credit risk/ default risk is very low. Offer good returns with low risk when interest rates are falling | Give slightly lower return that other long-term income funds which invest in corporate bonds. Returns not favourable when interest rates are rising | Credit risk is minimal. Interest rate risk in these funds is higher than short-term income funds. | Suitable for highly conservative investors (like trusts, pension funds etc.) not willing to invest beyond govt. securities | Depends on factors like outlook for interest rate, investor's investment horizon etc. |
| Income funds LT | Typically, such funds invest a major portion of the portfolio in long-term debt papers. | They offer better return than other short-term income funds in falling interest rate scenario | In a rising interest rate scenario, income funds may not give fruitful results. | Interest rate risk in these funds is higher than short-term income funds. | Apt to invest in long term funds in a declining interest rate scenario. | Depends on factors like outlook for interest rate, investor's investment horizon etc. |
| MIPs | Have an exposure of 70%-90% to debt and an exposure of 10%-30% to equities. | Offer better returns than income funds due to their gain from the upside of stock market. | Low return potential as compared to equity oriented funds | They are the most aggressive among all debt funds, due to their exposure to equities. | Suitable for conservative/debt investors who do not mind a small exposure to equities. | More than one year. |
| FMPs | They invest in debt papers whose maturity is in line with that of the fund | Interest rate risk is almost nil Due to favourable tax treatment of debt funds against bank fixed deposits, post tax returns are usually higher One can lock-in prevailing yields in the market by investing in the fund | Illiquidity due to lock-in period | Very low risk | Suitable for fixed deposit investors willing to have better post tax returns | FMPs offered for varying durations, such as 1 month, 3 months, 6 months, 1 year, 3years etc. Should be chosen based on one's requirement |
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