What Is a Debt Fund
Let me tell you directly: a debt fund is an investment vehicle, like a mutual fund or ETF, that puts most of its money into fixed income securities such as bonds and money market instruments.
You should know that a debt fund can hold short-term or long-term bonds, securitized products, money market instruments, or floating rate debt. On average, the fees for debt funds are lower than for equity funds because management costs are inherently lower.
These are often called credit funds or fixed income funds, and they fit into the fixed income asset category. Investors like you typically seek them out for preserving capital or getting low-risk income distributions.
Key Takeaways
Understand this: a debt fund is a mutual fund, ETF, or other pooled investment where the main holdings are fixed income investments. Fees are lower than on equity funds due to reduced management costs. You have options between passive and active debt fund products.
Debt Fund Risk
Debt funds invest in a broad range of securities with different risk levels. U.S. government debt is usually seen as the least risky. Corporate debt from businesses is rated by the company's credit quality.
Investment-grade debt comes from companies with stable outlooks and high credit ratings. High-yield debt, from lower-quality companies with growth potential, gives higher returns but more risk. Other types include developed market debt and emerging market debt.
Debt Fund Investing
You can pick from many low-risk debt fund options, both passive and active.
Passive Debt Funds
Some of the biggest passive fixed income funds track major indexes like the Bloomberg U.S. Aggregate Bond Index and the ICE U.S. Treasury Core Bond Index.
Examples of Passive ETFs
- iShares Core U.S. Aggregate Bond ETF (AGG): This tracks the Bloomberg U.S. Aggregate Bond Index with a net expense ratio of 0.03% and a 5-year average annual return of 0.83% as of Aug. 4, 2022.
- iShares U.S. Treasury Bond ETF (GOVT): This tracks the ICE U.S. Treasury Core Bond Index with a net expense ratio of 0.05% and a 5-year average annual return of 0.61% through Aug. 4, 2022.
Active Debt Funds
The market also has many active managers trying to beat indexes like the Bloomberg U.S. Aggregate Bond Index and the ICE U.S. Treasury Core Bond Index.
Take the First Trust Tactical High Yield ETF (HYLS) as an example; it's actively managed for income and capital appreciation, with a 5-year NAV return of 0.89% as of Aug. 4, 2022. It's not beating its index year-to-date but ranks high in the U.S. high yield bond category.
Overall, if you're investing in debt funds, pay attention to return calculations. These funds generate income, so they might pay monthly or quarterly dividends. Total return includes these payouts, while general returns might not.
Global Debt Funds
Countries issue debt to fund their fiscal policies. In the U.S., government debt is considered the lowest-risk fixed income investment.
U.S. Debt Funds
The U.S. government offers various securities you can invest in directly or through diversified debt funds. BlackRock’s iShares leads in indexed U.S. government debt ETFs.
U.S. corporate debt funds are divided by issuer credit quality. U.S. companies often have top global credit ratings, making these funds popular.
Global Debt Funds
Many countries provide debt investments for their fiscal needs. Risks and returns depend on the nation's political and economic situation. Like stocks, global corporate bond funds split into developed and emerging markets. Credit ratings for both government and corporate bonds use global standards.
Important Note
Even though debt funds are lower risk than equity funds, you need to watch out for interest rate risk.
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