Debt Funds: The Category and the Sub-Types Inside It

Debt funds are the grouping whose schemes lend rather than own. A scheme in it holds instruments under which somebody has promised to pay interest and return a principal amount at a stated date. Inside the grouping the Securities and Exchange Board of India (SEBI) defines named sub-types, and each one is separated from the others by who may be lent to and for how long. SEBI sets both.

Most of the trouble comes from the word itself, so start there. A debt fundA scheme in the grouping whose holdings are lending arrangements rather than shares in a company. is not called that because somebody judged it steady. The name comes from what the holdings are: arrangements in which the scheme has handed money over and holds a promise in return. The promise has two halves. Somebody will pay interest along the way, and somebody will return a principalThe amount lent, which the borrower has promised to return, as distinct from the interest paid on it. amount on a stated date. The grouping is named for an arrangement, and an arrangement is a fact about what the scheme holds rather than a claim about how the holding will behave.

Three sub-types inside that grouping are treated in detail below: the Gilt FundA defined sub-type built around lending to the government rather than to a company. What it must hold, and how much, is set by SEBI., the Liquid FundA defined sub-type built around a ceiling on how much life is left in the instruments it holds. The ceiling itself is set by SEBI. and the Money Market FundA defined sub-type built around money market instruments, with conditions on those instruments and on remaining life set by SEBI.. Every one of the three is a defined termA phrase whose meaning is fixed by a rule maker rather than by ordinary usage, so the plain English reading of it can be wrong. rather than a description, and that one fact is the most useful thing to know about all three at once.

Four things are settled elsewhere and are taken as given here. A scheme is a separate pool with its own property, its own accounts and its own value per unitWhat one unit of a scheme is worth, struck by dividing the scheme's net assets by the units in issue.. A category is a placement that carries conditions, and a scheme sits in exactly one of them under a name that has to match. Interest, principal and a lender are ordinary ideas established much earlier. And every regulatory value is fetched rather than remembered. Fetching is a working habit rather than a caution: a condition that moves by circular does not become merely dated on the day it changes, it becomes wrong.

Before the sub-types, one name. Girnar Asset Management Limited, an invented asset manager, runs the Girnar Large Cap Equity Fund and the Girnar Broad Market Index Fund, and no debt scheme at all. A debt scheme therefore has to be shown as an empty shape with every blank named for where it gets filled from, and the empty shape teaches the structure better than a filled one would. A filled example invites a reader to remember the value instead of the address.

What is a debt fund, and what is the word debt actually describing?

The word describes where the money went. Put two schemes side by side. The first buys a share in a company. Nobody has promised that anything comes back and nobody has named a date, so the holding is worth whatever somebody will pay for it. The second lends. Somebody has written down what they will pay in interest, and somebody has written down the date on which the principal amount falls due. The difference between holding a share of something and holding a promise about something is the whole basis on which the debt grouping is separated from the equity grouping.

Here is the everyday version. A cousin who puts money into a friend's catering business has bought a share of the business: if the business does well she does well, and nobody wrote a date on anything. A cousin who lends the same friend money for six months at an agreed interest has a promise instead, with a rate, a date and a claim if the date passes. Both cousins can lose money. The two cousins lose money in completely different ways, and their two arrangements are what the two groupings are named after.

Notice what has not been said. Nothing in that definition mentions steadiness, and nothing in it mentions a level of loss. A reader who quietly translates the word debt into the word safe has swapped a definition for a mood, and the swap is invisible because it happens in a single unspoken step. The grouping says the scheme lends. Whether the borrower pays, whether the promise is worth what it was yesterday, and how much the value per unit moves about are separate questions, and the grouping answers none of them.

What separates one debt sub-type from another?

Two questions do almost all of the work, and with them in hand a sub-type whose name has never been seen before can still be placed. The first is who may be lent to. The second is for how long. Every named sub-type in this grouping is a position on one of those two, or on both at once, and the positions themselves are conditions SEBI has written down and can revise.

Take the first axis on its own. At one end sits a sub-type that may lend only to the government. At the other end sit sub-types permitted to lend to a wider set of borrowers. Nothing about that axis is a judgement; it is a permission. Take the second axis. Some sub-types are defined by holding instruments with very little remaining lifeHow much time is left before an instrument is due to return its principal amount, counted from today rather than from when it was issued. left in them, and others sit further out. Again it is a permission, written as a condition, not a forecast.

The reason to carry the two axes rather than a memorised list of sub-type names is that the axes keep working on a name nobody has met before. A scheme document arrives carrying a sub-type name the reader cannot place. The list is not needed. The first question is who this scheme is permitted to lend to, the second is what the condition on remaining life is, and the two answers locate it on the same grid as everything else. The grid fixes which questions to ask and never fixes the answers, so the current conditions are then read at source.

A market vendor's lending book works the same way. She lends to two kinds of people: the shopkeepers on her own lane, whom she knows, and passing customers she does not. And she lends over two kinds of horizon, until the evening and until the end of the month. Any new arrangement she is offered gets placed on those two questions before anything else is discussed. She is not ranking the four boxes. She is locating the arrangement, a different and much earlier act.

What is a Gilt Fund, and what does lending to a government change?

A Gilt Fund is the sub-type built around the borrower rather than around the clock. A Gilt Fund is defined by lending to the government: the instruments it holds are issued by the government rather than by a company. How much of the scheme must sit in government issued instrumentsInstruments under which the government is the borrower, rather than a company or a bank. is not a matter of taste or of the manager's preference. The least holding is a condition, SEBI sets it, and the current one is read at sebi.gov.in.

Now the interesting part, and it is the part most readers get wrong. Changing the borrower changes one question and leaves a second question exactly where it was. The first question is whether the borrower pays as promised. Whether the borrower pays looks very different when the borrower is the body that issues the currency the loan is written in, and it is honest to say the question is different rather than to say it has gone away. The second question is what an existing loan is worth today when the going rate for new lending has moved. What an existing loan is worth today has nothing to do with who borrowed, so a Gilt Fund answers the first question differently and does not touch the second one at all.

Consider a promise being held rather than a promise being made. Suppose a neighbour agreed months ago to pay a household a fixed amount every month for two years. If lenders on the lane are now getting more for new arrangements than that neighbour agreed to pay, then the household's piece of paper, on the day it is handed to somebody else, is worth less than it was. Nobody broke a promise. The going rate moved underneath a promise that had already been made. The loss of value is real, it happens to promises made by any borrower, and no borrower is exempt from it because the borrower is not what changed.

What is a Liquid Fund built around?

A Liquid Fund is built around the clock rather than around the borrower. Its definition turns on a ceiling: the instruments it holds may have only so much remaining life left in them, and no more. The ceiling is doing almost all the work in the sub-type, and two consequences follow from it in a fairly direct way. Because the instruments are close to falling due anyway, money can be returned to holders quickly. And because there is less time left for a change in the going rate to act on, the instruments tend to move less from one day to the next than something with years left to run.

The ceiling on remaining life is the definition, not a description of it. The whole sub-type therefore sits on a single value that SEBI sets, and SEBI can revise it. A ceiling copied out and left to sit for months is read years later with the same confidence as a current one, and that confidence is what makes a copied value worse than no value at all. The ceiling exists, it constrains remaining life, and its current value is read at sebi.gov.in.

One further point is worth flagging. Schemes at the very short end of this grouping are treated differently in some of the surrounding rules, including in how the day whose value per unit applies to a transaction is worked out. A different treatment exists. Both the treatment itself and which schemes it covers are a SEBI matter.

What is a Money Market Fund built around, and how is it not the Liquid Fund?

A Money Market Fund is built around the instrument. Money market instrumentsThe short dated instruments through which banks, companies and the government borrow for brief periods. Which instruments count is a defined list rather than a general description. are the short dated arrangements through which banks, companies and the government borrow for brief periods, and the sub-type is defined by holding those, with conditions attached to the instruments themselves and to remaining life.

Set those two definitions back to back and the problem shows. A Liquid Fund holds things with very little remaining life. A Money Market Fund holds short dated instruments. In ordinary English those are the same sentence twice, and a reader trying to tell the two apart from the words alone is being asked to do something the words cannot do. The separation between the two is carried entirely by conditions SEBI sets, on which instruments qualify and on how much life may be left in them, so the honest answer to what separates them is an address rather than a sentence.

A reproduced set of separating conditions would be right for as long as those conditions stood and silently wrong afterwards, and a reader would have no way of telling which of the two states they were in. The address at sebi.gov.in keeps working instead: it carries the knowledge that the two are separated by conditions, the knowledge of which conditions to look for, and the place they live.

Why do these names sound like descriptions when they are defined terms?

Because they were built out of ordinary words that already meant something. Liquid, in everyday speech, means the money can be got at. Gilt carries an old sense of something gold edged and fine. Money market sounds like a place where money is traded. Every one of those readings will get a reader roughly to the right neighbourhood. Being roughly right is precisely the trouble. A word that misled a reader every time would be harmless. Trust in it would end after the first surprise.

Reasoning from the everyday meaning of one of these names is right often enough to stop the checking, and being right often is what makes the occasional exception expensive. The reader who has been approximately right for two years does not check on the day the approximation fails. Nothing about that day announces itself as different. The defence is not a better instinct about the words. The defence is a habit: when a word in a scheme name is a defined term, the current definition gets looked up, and it gets looked up whether or not the word sounds obvious.

The habit already runs elsewhere, unnoticed. In an office, a working day and a business day are not idle synonyms; somebody wrote down which days count. On a train ticket, a child fare has an age condition attached, and no amount of looking at a child settles it. In both cases the ordinary word survives inside a rule that fixes it, and the sensible person reads the rule rather than the word. Scheme sub-type names are the same shape of thing.

Does a debt scheme's value per unit move, and why?

The value per unit moves, and it moves for two reasons worth keeping apart. The two reasons have different causes and they feel completely different when they happen.

The first reason is that a borrower may not pay as promised. A promise is only as good as the party who made it, and when that party fails to do what the document said, what the scheme holds is worth less than the document implied. The second reason has nothing to do with anybody failing. The going rate for new lending moves. When the going rate moves, an existing loan written at an older rate is worth a different amount today. Anybody weighing up that promise now compares it against what they could get instead. Nothing was broken. The comparison changed.

Both movements are ordinary and neither is a defect in the scheme. A surprised holder most needs that sentence and least expects it. A scheme whose value per unit never moved would not be a better run scheme; it would be a scheme that was not marking what it held to anything. How each of these two movements is measured, and how a manager might position against either, belongs to the sequence on lending instruments and to the portfolio subject area respectively. Both movements are named here so that neither arrives as a shock.

What does the debt grouping not settle about a scheme inside it?

Almost everything a reader would want to know next. The grouping does not settle what the scheme costs. A category fixes what may be held and does not fix a charge. It does not settle where inside the permitted range the holdings actually sit, since a permitted range is a boundary and a manager works somewhere inside it. It does not settle how the manager positions against either of the two movements above. Positioning is a portfolio question covered separately. And it certainly does not settle how the value per unit will behave. Nothing settles that.

Then there is the sentence a reader needs most, and it belongs here rather than buried in a caution at the bottom. A scheme in this grouping is not a deposit, no amount is promised back to a holder, and the grouping was never a statement about safety in the first place. A deposit is an arrangement in which a bank has promised the depositor an amount at a date. A unit in a scheme is a share of a pool whose value is struck each day from what the pool holds. A deposit and a unit are different arrangements. The scheme lends, so somebody has promised the scheme something. Nobody has promised the holder anything.

The household version sits next to it. If a neighbour has promised to repay a household by Diwali, the household holds a promise. If instead that household and four neighbours pooled money and lent it on together, each holding a share of the pool, none of them holds a promise from the pool; each holds a share of whatever the pool turns out to be worth. Both arrangements can be perfectly sensible. Only one of them ends with somebody owing a stated amount, and knowing which arrangement is in play is the whole point.

What does a worked debt scheme look like when the record carries none?

Girnar Asset Management Limited runs the Girnar Large Cap Equity Fund and the Girnar Broad Market Index Fund, and no debt scheme at all. So there are no net assets to divide, no unit count to divide by, and no result to report for a debt scheme.

The shape of one can be built instead. Three cards, one for each of the three named sub-types, carrying identical rows. Six rows each. The sub-types differ along the same axes every single time. The cards are blank in exactly the places a reader would most want them filled, and every blank carries an address rather than a value. An address keeps working where a value goes stale.

The rows split into two kinds. Four of them are set by a rule maker and are the same for every scheme calling itself by that sub-type name: who may be lent to, the least that must be held of it, the condition on remaining life, and what the scheme name is allowed to claim. Those four are fetched from SEBI at sebi.gov.in. Two of them belong to the individual scheme and vary from one scheme to the next inside the same sub-type: the benchmark its result is reported against, and its own expense ratio. Those two are read off that scheme's own document, and they are blank here only because no such document exists in this record.

Read along the rows rather than down the cards and the point lands. The same skeleton appears three times. Nothing about the shape of a sub-type changes from one card to the next; only the position on the two axes changes, and the position is a condition somebody else publishes. The skeleton is the whole structure of the grouping, and the structure survives being read out loud over a phone call because it is a shape rather than a set of values.

Where does a reader find what each sub-type is currently permitted to hold?

At one address, for every condition named in this guide: what the debt grouping is as a defined category, how many named sub-types sit inside it, the least a Gilt Fund must hold in government issued instruments, the condition on remaining life that defines a Liquid Fund, the instrument and remaining life conditions that define a Money Market Fund, the measure separating the sub-types not named here, and any exit condition attached to leaving a very short dated scheme quickly.

Seven conditions are named in this guide, and one discipline covers all seven rather than seven separate ones. Every one of the seven is set by SEBI and read at sebi.gov.in. The Association of Mutual Funds in India (AMFI), at amfiindia.com, publishes industry level material and the classification list a scheme's holdings are measured against, and is the right next stop for that; it is not the maker of any of these rules.

Girnar Asset Management Limited, the Girnar Large Cap Equity Fund, the Girnar Broad Market Index Fund, Kalyani Bhagat and Sohail Merchant are invented.
Educational material. Not advice on any investment, tax, budget or market position.