It’s a misconception that Debts Fund have no risk just because they don’t invest in equities. It’s true that Debt Funds are less risky compared to Equity Funds but that doesn’t mean Debt Funds guarantee that your money will never face any loss. Debt funds invest in debt and money market securities that are prone to different kind of risk factors as compared to equity funds that invest in stock market.
Debt Funds are exposed to interest rate risk, credit risk and liquidity risk that are quite different from the stock market risk we all are familiar with. While these risk factors are not as pronounced as stock market risk on an everyday basis, they can’t be ignored completely.
Interest rate risk arises due to changes in interest rates that affect the prices of bonds the Debt Fund has invested in. Credit risk arises when there is a financial crisis in any of the companies whose bonds the debt fund has invested in because this makes the payment of interest and principal due on these bonds extremely uncertain. Liquidity risk arises in case of debt securities that are not frequently traded and hence the fund may be forced to sell these securities in its portfolio at a loss under unfavourable circumstances. Hence investing in Debt Funds may be relatively less risky as compared to Equity Funds but not completely risk-free.