Looking to invest in debt funds for a 1-3 year horizon? Expert shares 4 categories you can consider

If you're planning to invest in debt mutual funds for the next one to three years, keeping things simple may be the best strategy.

In a recent post on X, Sanjay Kathuria shared insights from an episode of the Sanjay Kathuria Podcast featuring Kirttan Shah, Founder & CEO of Truvanta Wealth.

The discussion centred on the debt fund categories that may be most suitable for investors looking to park money for one to three years.

Which debt funds are suitable for a 1-3 year investment horizon?

Sharing the key takeaway from the discussion, Kathuria wrote, “For a 1-3 year horizon, there are really only 4 categories of debt worth looking at. Short duration funds, dynamic bond funds, corporate bond funds, and banking and PSU funds.”

Short duration funds

As per SEBI’s categorisation norms, short duration funds invest in debt and money market instruments such that the portfolio’s Macaulay duration remains between one and three years. They are designed for investors with a similar investment horizon and limit the interest rate risk as compared to the long duration funds.

Dynamic bond funds

Unlike other debt funds, dynamic bond funds do not have a fixed maturity profile. Fund managers actively adjust the portfolio's duration depending on the interest rate outlook.

Corporate bond funds

These funds must invest at least 80% of their total assets in highest-rated corporate bonds (AA+ and above). Kathuria also highlighted that “corporate bond funds are interesting because 80% of the money legally has to sit in triple-A rated bonds, the safest category there is. The fund manager isn't even allowed to go lower for that 80%.”

Banking & PSU funds

These funds invest at least 80% of their assets in debt instruments issued by banks, Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs) and municipal bonds. Since the underlying issuers are generally considered financially stronger, these funds typically carry relatively lower credit risk.

Why are credit risk funds different?

He further noted, “Across every debt fund category in India, there's only one where fund managers are actually allowed to take real credit risk on purpose. It's literally called credit risk fund. Everywhere else, they stay as close to triple-A as possible.”

As per SEBI's categorisation norms, credit risk funds are required to invest at least 65% of their assets in corporate bonds rated AA and below. Unlike most other debt fund categories that primarily invest in higher-rated securities, these funds can take exposure to lower-rated bonds in an attempt to earn higher yields.