Debt Funds — Medium and Long Term, Dynamic Term, Corporate Bond, Credit Risk, Gilt
Longer-dated debt categories are defined by Macaulay duration, and several others by what they hold: bonds of a given rating, government securities, bank and PSU debt, floating-rate instruments or one sector. This lesson sets out each rule and the two risks behind them.
Categories defined by duration
A Medium Term Fund keeps its Macaulay duration between 3 and 4 years, a Medium to Long Term Fund between 4 and 7 years, and a Long Term Fund above 7 years. The Medium Term band applies in normal conditions; it may be shortened, with disclosure, when the fund manager expects an adverse interest-rate situation.
A Dynamic Term Fund, earlier called Dynamic Bond, invests across durations. It has no fixed band, so its duration can be long at one time and short at another.
Categories defined by holdings
A Corporate Bond Fund holds at least 80% in corporate bonds rated AA+ and above, the highest grades on the rating scale. A Credit Risk Fund holds at least 65% in corporate bonds rated AA and below, with AA+ excluded. A Banking & PSU Fund holds at least 80% in debt of banks, public sector undertakings and public financial institutions, with municipal bonds included.
A Gilt Fund holds at least 80% in government securities, and there is also a 10-year Constant Maturity Gilt Fund. A Floating Interest Rate Fund holds at least 65% in floating-rate instruments. The Sectoral Debt Fund, new in 2026, holds at least 80% in bonds rated AA+ and above from one of five named sectors.
Gilt, Corporate Bond and Dynamic Term funds have no duration band.
Two separate risks
Interest-rate risk grows with duration. As a rough guide, the percentage change in NAV is the duration multiplied by the change in yield, in the opposite direction, so longer duration means larger NAV swings when rates change.
Credit risk is the risk that an issuer delays or fails to pay. Lower-rated bonds pay higher interest because the chance of default is greater, so a Credit Risk Fund carries more credit risk than a Corporate Bond Fund.
The two risks do not cancel out. A Gilt Fund's main risk is interest-rate risk. A high rating lowers credit risk but leaves interest-rate risk in place. Bank and PSU bonds do not carry a general government guarantee.
Rules at a glance
A default in a Credit Risk Fund (illustrative arithmetic)
Assume a Credit Risk Fund has 3% of its portfolio in one lower-rated bond. The issuer defaults, and the bond's value is marked down by 60%. The fund's NAV falls by about 3% × 60% = 1.8%, whatever interest rates are doing that day.
Longer duration, larger swing (rough guide, assumed figures)
- Assume a Medium Term Fund with a Macaulay duration of 3.5 years and a Long Term Fund with a duration of 8 years, each with an NAV of ₹40.00. Yields rise by 0.50 percentage point.
- Medium Term Fund: 3.5 × 0.50% = 1.75% fall. 1.75% of ₹40.00 = ₹0.70, so the NAV moves to about ₹39.30.
- Long Term Fund: 8 × 0.50% = 4.00% fall. 4.00% of ₹40.00 = ₹1.60, so the NAV moves to about ₹38.40.
Result. For the same rise in yields the Long Term Fund falls by about 4.00% and the Medium Term Fund by about 1.75%; a fall in yields of the same size would lift them by about the same percentages. These are approximations: the strict calculation uses modified duration.
Key points
- Macaulay duration bands: Medium Term 3 to 4 years, Medium to Long Term 4 to 7 years, Long Term over 7 years.
- A Dynamic Term Fund, earlier Dynamic Bond, invests across durations with no fixed band.
- A Corporate Bond Fund holds at least 80% in bonds rated AA+ and above; a Credit Risk Fund at least 65% in bonds rated AA and below.
- A Banking & PSU Fund and a Gilt Fund each hold at least 80% in their defined instruments; a Floating Interest Rate Fund at least 65%.
- The Sectoral Debt Fund is new in 2026: at least 80% in AA+ and above bonds of one of five named sectors.
- Longer duration means larger NAV swings; lower ratings mean higher default risk.
Common misunderstandings
- A Gilt Fund is not free of risk: its main risk is interest-rate risk, and its NAV can fall when yields rise.
- A Banking & PSU Fund is not government-guaranteed: these bonds carry no general government guarantee, and the NAV still moves with interest rates.
- AA+ bonds do not count towards a Credit Risk Fund's 65%: that floor is for bonds rated AA and below.
- Not every debt category has a duration band: Gilt, Corporate Bond and Dynamic Term funds have none.
Questions people ask
Why do lower-rated bonds pay more interest?
Because the chance of default is greater. The extra interest comes with extra credit risk, which is why a Credit Risk Fund is riskier on this count than a Corporate Bond Fund.
Can a Medium Term Fund's duration go below 3 years?
In normal conditions it stays between 3 and 4 years. It may be shortened, with disclosure, when the fund manager expects an adverse interest-rate situation.
What is new about the Sectoral Debt Fund?
It is a new debt category under the 2026 categorisation, holding at least 80% in bonds rated AA+ and above from one of five named sectors.
What this lesson relies on
- SEBI Master Circular for Mutual Funds (20 March 2026) — Chapter 3, categorisation of mutual fund schemes
- SEBI circular of 26 February 2026 on categorisation of mutual fund schemes
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.