What Are Debt Funds?
A debt fund is an investment pool, such as a mutual fund or exchange-traded fund (ETF), where the primary holdings consist of fixed income investments. These investments can include short-term or long-term bonds, securitized products, money market instruments, or floating rate debt. On average, management fees for debt funds are lower than those for equity funds due to the inherently lower management costs.
Debt funds, often referred to as credit funds or fixed income funds, fall under the fixed income asset category. They are ideal for investors aiming to preserve capital and achieve low-risk income distributions.
Key Takeaways
- Debt Funds Definition: A debt fund is a mutual fund, ETF, or other pooled investment vehicle that primarily invests in fixed income securities.
- Low Management Fees: Management fees for debt funds tend to be lower than those for equity funds.
- Investment Options: Investors can choose between passive and active debt fund products based on their investment goals.
Assessing Risk in Debt Funds
Debt funds can invest in a wide variety of securities, each with its unique risk profile. U.S. government debt is considered among the least risky investments. Corporate debt issued by businesses carries varying levels of risk, often determined by the company’s credit rating.
- Investment-Grade Debt: Issued by companies with high credit quality and stable outlooks, offering lower risk.
- High-Yield Debt: Issued by companies with lower credit quality but potential for higher growth, offering higher returns along with greater risk.
- Market Debt Categories: Includes developed and emerging market debt.
Different Approaches to Debt Fund Investing
Investors can choose from numerous low-risk debt fund options, available in both passive and active formats.
Passive Investment Options
Some of the most popular passive fixed income funds seek to replicate leading fixed income benchmark indexes. Examples include:
- iShares Core U.S. Aggregate Bond ETF: Tracks the Bloomberg U.S. Aggregate Bond Index with a net expense ratio of 0.03%. Its 5-year average annual return is 0.83% as of Aug. 4, 2022.
- iShares U.S. Treasury Bond ETF: Replicates the ICE U.S. Treasury Core Bond Index with a net expense ratio of 0.05%. Its 5-year average annual return is 0.61% as of Aug. 4, 2022.
Active Investment Options
Actively-managed debt funds aim to outperform established indexes such as the Bloomberg U.S. Aggregate Bond Index. For example:
- First Trust Tactical High Yield ETF: This actively-managed fund focuses on income and capital appreciation, with a 5-year NAV return of 0.89% as of Aug. 4, 2022.
Performance Indicators
Investors should be familiar with various return calculation methods and understand that total return calculations include income payouts, whereas general return calculations may not.
Exploring Global Debt Funds
Countries issue debt to support their governmental fiscal policies, making both national and global debt funds viable options for investors.
U.S. Debt Funds
The U.S. government offers a range of securities, and investors can either invest directly or opt for diversified funds like those managed by BlackRock’s iShares. U.S. corporate debt funds are highly sought after due to the high credit ratings of American companies.
Global Debt Funds
Governments worldwide issue debt to stabilize their economies. The risks and returns of global debt funds vary depending on each nation’s political and economic climate. Government and corporate bonds can be segmented based on developed or emerging market indexes, with credit ratings to guide investors.
Final Thoughts
Though generally lower risk than equity funds, debt funds still carry interest rate risk that investors should be aware of. Nonetheless, debt funds offer a robust tool for capital preservation and reliable income generation.
Related Terms: mutual fund, fixed income, credit rating, preservation of capital, interest rate risk.
References
- iShares. “iShares Core U.S. Aggregate Bond ETF”.
- iShares. “iShares U.S. Treasury Bond ETF”.
- First Trust. “First Trust Tactical High Yield ETF (HYLS)”.
- VettaFi. “Government Bond ETFs”.
