Debt & hybrid mutual funds suitable for a long-term investment portfolio

Readers often ask, “What debt fund should I add to a long term investment portfolio?” After gains from debt mutual funds became taxable as per slab (applicable to units purchased from 1st April 2023), more readers have sought tax-efficient options. So here is an updated list of debt & hybrid mutual funds suitable for a long-term investment portfolio.

General thumb rules:

1. Never change fund categories only to save tax unless you have a huge net worth or have considerable experience (this means having seen both up and down-market years in the bond segment and not just years invested)
2. The risk and reward profile will change if you change the fund category. The risk will almost always increase. This means the return spread and the possibility of a negative or a poor return increases.
3. Never change fund categories for short-term goals.  “Short-term: is less than 10Y for newbies and less than 5Y for experienced investors).

List of debt & hybrid mutual funds suitable for a long-term investment portfolio

1 Gilt Funds

Investors must appreciate that these funds are also dynamic bond funds and will have variable interest, duration, and demand-supply risks.

• HDFC Gilt Fund Direct Plan-Growth Option
• ICICI Pru Gilt Fund Direct Plan-Growth Option
• SBI Gilt Fund Direct Plan-Growth Option
• Each fund in this category would have its own style. So, investors must study the history of investment style from factsheets before investing. See: How to choose a gilt mutual fund.
• Suitable only for long-term goals. For first-time investors, 10Y or more. The NAV will fluctuate rapidly here, too, but less than the 10Y gilt category.
• It can give years of poor returns! Only for those who are patient!
• Disclosure: I am invested in the ICICI Gilt fund. See: Why I partially switched from ICICI Multi-Asset Fund to ICICI Gilt Fund.

2 Corporate Bond Funds

These are for investors who want lower NAV volatility than gilt funds. The risk of credit defaults or NAV changes due to rating up or downgrades is higher than that of gilt funds. See: Can we use HDFC Corporate Bond Fund for long-term goals?

• HDFC Corporate Bond Fund Direct Plan-Growth Option
• ICICI Pru Corporate Bond Fund Direct Plan-Growth Option
• SBI Corporate Bond Fund Direct Plan-Growth Option
• Each fund in this category would have its own style. So, investors must study the history of investment style from factsheets before investing.
• Suitable only for long-term goals. For first-time investors, 10Y or more. The NAV will fluctuate rapidly here, too, but less than the 10Y gilt category.

3 Conservative Hybrid

• Duration: Strictly long term, at least 10Y or more, with proper asset allocation and periodic rebalancing.
• Parag Parikh Conservative Hybrid Fund Direct Plan-Growth Option
• It can be used as an alternative to gilt funds* as a debt component in a long term portfolio.
• *This fund invests in long-term state government bonds + a small amount of equity + a small amount in REITs. During stock market crashes, the NAV will fall! So be prepared for this.  The NAV will be volatile even on normal days!
• Also see: Who should invest in Parag Parikh Conservative Hybrid Fund?
• Disclosure:  I am invested in this fund for both long-term goals. See: Why I started to invest in Parag Parikh Conservative Hybrid Fund.
• Note: I will direct future investments in the tax-efficient Parag Parikh Dynamic Asset Allocation Fund because, for my needs, this new fund has a similar risk profile. I do not recommend this to everyone. See: Parag Parikh Dynamic Asset Allocation Fund: Who should invest?

4 Other options

• Edelweiss CRISIL IBX 50:50 Gilt Plus SDL Short Duration Index Fund is an open-ended debt Index Fund investing in the constituents of CRISIL IBX 50:50 Gilt Plus SDL Short Duration Index. The index will comprise 50% gilts and 50% State Development Loans (SDLs) spread among four duration buckets: 1-2 years, 2-3 years, 3-4 years and 4-5 years. For more details, see Edelweiss Short Duration Index Fund: Who can invest? Use for long-term goals only. The fund will typically be less volatile than a gilt fund but may also be less rewarding over the long term.
• Parag Parikh Dynamic Asset Allocation Fund will predominantly invest in debt instruments and endeavour to maintain equity allocation between 35% and 65%* (some of it will be hedged via approved derivative instruments ). This is a risky option suitable only for experienced investors. It could have considerable direct equity exposure. During stock market crashes, the NAV can fall significantly!

5 Conservative choices suitable for short-term goals or corpus de-risking

These may be used for long-term goals as well by risk-averse investors, but the reward may be lower than the choices mentioned above. For fund recommendations, see Handpicked List of Mutual Funds (PlumbLine)

1. Liquid funds: These may be used for short-term (< 5Y) and intermediate-term (<10Y) goals and also when a long-term goal nears its deadline. This will work well if you wish to accumulate the target corpus in debt gradually. Yes, it is a conservative choice, but not all investors know how to navigate debt funds.
2. Money market funds are a bit riskier than liquid funds but are a good choice for gradually accumulating the target corpus in debt.
3. Arbitrage funds: A tax-efficient choice (since it is considered an equity fund) but will be a bit more volatile than a money market fund. It can be used for the same purpose as above. So all three choices are well suited for one-way “rebalancing”: permanent shifting funds from equity to debt. The goal here is to safeguard the corpus, but the rate of return is not a primary concern.