Debt Funds invest their investors’ money in interest-bearing securities like bonds, corporate deposits, G-secs, money market instruments, etc. These bonds are like certificates that carry an obligation on the part of the bond issuer to pay regular interests (coupons) to the bond investors. Thus, debt funds earn regular interest income from such securities held in their portfolio. The interest earned by a debt fund from its bond portfolio can either be distributed among investors or accrued to the fund i.e. added to the fund assets, leading to an increase in NAV. Thus, unlike equity funds which depend on divided distribution from their portfolio of stocks, debt funds have a regular interest income, from the underlying portfolio, built into their features.
As an investor, you can opt for a dividend payout option if you wish to receive regular income from your debt funds. While the option is named as ‘Dividend Payout’, it distributes the interest income and other capital gains earned from its portfolio at regular intervals. Even though the portfolio of a Debt Fund comprises of interest-paying securities, making its dividend distribution more predictable and regular than that of an Equity Mutual Fund, these dividends are not guaranteed. Dividends are paid only when the fund has a distributable surplus. Talk about distributable surplus and that income will not be regular always.