February 3, 2024

Income Mutual Funds - What Is An Income Fund?

Income Mutual Funds – What Is An Income Fund?

An Income Fund is a kind of Debt Mutual Fund investing in instruments like corporate bonds and government securities. It’s a long-term investment aimed at providing regular, fixed income to investors rather than focusing on building a large investment corpus.

Contents:

Income Mutual Funds Meaning

Income Funds, a category of debt funds, invest in long-term debt instruments such as debentures, corporate bonds, and government securities. SEBI defines them as debt funds with a Macaulay Duration of four years or more.

Income Fund Example

Examples of income funds include the Templeton India Equity Income Fund, with an AUM of ₹1880.55 Cr, a NAV of ₹127.37, and a 3-year CAGR of 26.33%; the Bank of India Short Term Income Fund, with an AUM of ₹89.66 Cr, a NAV of ₹25.48, and a 3-year CAGR of 12.11%; and the SBI Magnum Income Fund, which has an AUM of ₹1708.83 Cr, a NAV of ₹67.20, and a 3-year CAGR of 5.47%.

How do Income Mutual Funds work?

Income mutual funds work by investing in high-credit-rated fixed income securities like debentures and bonds. Fund managers aim for income maximization through capital appreciation and dividend payouts, adjusting strategies in different interest rate scenarios to ensure returns, often surpassing traditional bank deposits.

This maximization manifests in two ways: 

  1. Capital appreciation, where the fund’s net asset value (NAV) increases over time.
  2. And dividend payouts, which are distributed at periodic intervals based on surplus funds.

In terms of strategy, fund managers actively manage the portfolio to deliver good returns in varying interest rate environments, whether they are rising or falling. This involves two main approaches: generating interest income by holding debt instruments until maturity, and earning gains by selling them in the market when their prices increase. 

These funds typically opt for debt instruments that offer higher security (high-quality rating) and lower interest rate risk. Historically, income funds have tended to provide better returns than traditional bank deposits, offering more flexibility and liquidity to investors.

Types Of Income Fund

Types of income mutual funds include Dynamic Bond Funds, which adjust investments based on interest rates; Corporate Bond Funds, investing in high-rated corporate bonds; Credit Risk Funds, focusing on higher-risk, higher-return securities; Gilt Funds, solely in government securities; and Fixed Maturity Plans (FMPs), with a set maturity date.

Dynamic Bond Funds: Dynamic Bond Funds adapt their investment strategy based on changing interest rate scenarios. They invest across various debt instruments with different maturities, allowing fund managers to capitalize on interest rate movements to optimize returns for investors.

Corporate Bond Funds: These funds primarily invest in high-rated corporate bonds, focusing on generating income through interest accruals. They target companies with solid financial stability and lower risk of default, offering a blend of safety and reasonable returns.

Credit Risk Funds: Credit Risk Funds invest a significant portion of their portfolio in lower-rated securities, which carry higher risk but also the potential for higher returns. They aim to earn higher income through the increased interest rates these securities offer.

Gilt Funds: Gilt Funds invest exclusively in government securities. They are considered low-risk as they are backed by the government. These funds are suitable for investors looking for safe investment options, though they are still subject to interest rate risks.

Fixed Maturity Plans (FMPs): FMPs are closed-ended debt funds with a fixed maturity date, investing in instruments that align with their tenure. They aim to provide stable returns and tax efficiency, and are suitable for investors with a specific investment horizon in mind.

Income Fund Vs Growth Fund

The main difference between income funds and growth funds is that income funds focus on generating regular earnings through dividend-paying securities, while growth funds aim for capital appreciation and reinvestment for higher growth potential.

Objective

Growth funds aim for capital appreciation through reinvestment in high-growth companies, ideal for long-term wealth creation. In contrast, income funds focus on steady earnings via dividends, targeting investors seeking regular income, a key consideration in the Indian market’s diverse investment landscape.

Risk Profile

Growth funds present higher risk due to market volatility, appealing to risk-tolerant investors in India’s dynamic economy. Income funds, however, offer lower risk by investing in stable, dividend-paying securities, aligning with the conservative investment approach prevalent among many Indian investors.

Investment Strategy

In growth funds, profits are reinvested for company expansion, targeting sectors with high growth potential in India, like technology and healthcare. Income funds distribute profits as dividends, focusing on established sectors with consistent dividend payouts, such as Indian public sector units and FMCG companies.

Return Potential

Growth funds offer higher potential returns through capital gains, particularly beneficial in India’s rapidly growing economy. Income funds provide regular, predictable returns through dividends, catering to those in the Indian market who prioritize income stability over high growth.

Investor Suitability

Growth funds suit investors in India looking for aggressive growth and willing to tolerate market fluctuations. Income funds are preferred by those seeking stable, regular income, often appealing to retirees or conservative investors in the Indian context.

Advantages of Income Funds

The main advantage of an income mutual fund is its ability to provide a regular and potentially higher income stream compared to traditional fixed-income investments, along with the flexibility of no lock-in periods and tax efficiency for those in higher tax brackets.

Other Advantages Include:

Diversification: Income funds invest in a variety of income-generating assets like bonds and dividend-paying stocks, providing diversification. This spread of investments can reduce risk compared to investing in a single asset class, making it a suitable option for investors seeking balanced exposure in the Indian market.

Regular Income Stream: These funds are tailored to provide a steady income stream, typically through dividends or interest payments. This feature is particularly attractive for retirees or investors who require a regular income flow, aligning well with the needs of a significant segment of Indian investors.

Higher Returns than Fixed Deposits: Income funds often yield better returns compared to fixed deposits, making them a more lucrative option. However, they do carry credit and interest rate risks, unlike fixed deposits, which are generally risk-free. This makes income funds suitable for those who can manage moderate risk.

No Lock-in Period: Unlike fixed deposits that may penalize for early withdrawal, income funds typically have no lock-in periods, offering greater liquidity. Some funds may have an exit load, so it’s important to review the terms before investing, especially for investors who may need early access to funds.

Tax Efficiency for High-Income Earners: For those in the 30% income tax bracket, income funds offer significant tax advantages. Long-Term Capital Gains (LTCG) in income funds are taxed at 20% with indexation benefits, whereas interest from fixed deposits is taxed as per the individual’s tax slab, often resulting in higher tax outgo.

Disadvantages of Income Funds

Risk from Interest Rate and Credit: Income funds are sensitive to interest rate changes; a rise in rates can decrease bond prices, reducing fund value. Additionally, there’s the credit risk of default by bond issuers, which can adversely affect returns, making these funds riskier than perceived.

Return Dependent on Interest Rate Volatility: While income funds can capitalize on falling interest rates to generate returns, they do not guarantee returns like fixed deposits. Their performance is closely tied to interest rate movements, making them less predictable and dependable for conservative investors.

Expense Ratio Costs: Income funds incur management fees, known as the expense ratio. For instance, investing Rs. 10,000 in a fund with a 2% expense ratio means paying Rs. 200 for fund management. This fee can impact overall returns, especially in low-yield environments.

Market Sensitivity: These funds are susceptible to market fluctuations, making them less stable compared to risk-free investments like government bonds. This market sensitivity can lead to periods of underperformance, especially in volatile economic conditions.

Liquidity Risk: While generally more liquid than fixed deposits, some income funds may face liquidity issues, especially in stressed market conditions. This can affect the fund’s ability to meet redemption requests promptly, posing a risk for investors needing quick access to their funds.

Income Fund Returns

The table below shows the Best Income Mutual Funds based on a 1-year return.

NameAMCAbsolute Returns – 1Y %
Templeton India Equity Income FundFranklin Templeton Asset Management (India) Private Limited35.03
SBI Magnum Income FundSBI Funds Management Limited7.56
Nippon India Income FundNippon Life India Asset Management Limited7.52
HDFC Income FundHDFC Asset Management Company Limited7.32
Aditya Birla SL Income FundAditya Birla Sun Life AMC Limited6.76
Canara Rob Income FundCanara Robeco Asset Management Company Limited6.51
Bank of India Short Term Income FundBank of India Investment Managers Private Limited6.30

Best Income Mutual Funds

The table below shows the Best Income Mutual Funds based on a 3-year CAGR.

NameAUM (in Cr)NAV ( Rs )CAGR 3Y ( % )
Templeton India Equity Income Fund1880.55127.3726.33
Bank of India Short Term Income Fund89.6625.4812.11
SBI Magnum Income Fund1708.8367.205.47
Nippon India Income Fund265.5888.415.14
Aditya Birla SL Income Fund1757.70119.774.92
HDFC Income Fund710.4356.614.53
Canara Rob Income Fund124.1455.074.45

Income Mutual Funds – Quick Summary

  • Income mutual funds invest in long-term debt instruments, focusing on returns from corporate bonds and government securities.
  • Examples include Templeton India Equity Income Fund and SBI Magnum Income Fund, focusing on long-term debt instruments with various returns.
  • Income funds invest in high-credit-rated securities, aiming for income maximization through capital appreciation and dividend payouts.
  • Include Dynamic Bond Funds, Corporate Bond Funds, Credit Risk Funds, Gilt Funds, and Fixed Maturity Plans, each with distinct strategies.
  • Income funds generate regular earnings via dividends, while growth funds focus on capital appreciation and reinvestment for higher growth.
  • Income funds offer a regular, potentially higher income stream, with flexibility and tax efficiency compared to fixed-income investments.
  • Sensitive to interest rate changes and credit risks, income funds can face reduced value and returns, presenting higher risk levels.
  • Top funds include Templeton India Equity Income Fund and Bank of India Short Term Income Fund, offering varied 3-year CAGR returns.

Income Mutual Funds Meaning – FAQs  

1. What Is An Income Mutual Fund?

An Income Fund, a type of Debt Mutual Fund, invests primarily in corporate bonds and government securities, aiming to deliver regular, fixed income over the long term.

2. Is It Good To Invest In Income Fund?

Investing in Income Funds can be suitable for those seeking regular income and lower risk compared to equity investments, but it depends on individual risk tolerance and financial goals.

3. What Is The Difference Between Income Mutual Funds And Growth Mutual Funds?

The main difference between income funds and growth funds is that income funds prioritize regular earnings from dividend-paying securities, whereas growth funds focus on capital appreciation, reinvesting earnings to achieve higher long-term growth, appealing to different investment strategies and risk appetites.

4. Who Should Invest In Income Fund?

Investors seeking steady income, particularly those in retirement or with a lower risk appetite, may find Income Funds suitable, but it’s important to align with individual financial goals and risk tolerance.

5. Are Income Funds Safe?

Income Funds, while generally safer than equity investments, carry risks like interest rate fluctuations and credit risk, making them relatively safe but not entirely risk-free investment options.

6. How Do I Invest In Income Funds?

You can start investing in Income Funds for free by opening an account with Alice Blue in 15 minutes.

7. Do Income Funds Pay Dividends?

Mutual funds, based on their portfolio composition, can disburse dividends or interest, or sometimes both, and are legally required to distribute accumulated dividends at least annually.

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