Equity Funds invest in stocks of companies while Debt funds invest in bonds of companies and money market instruments. Since these funds invest our money in different assets, they are impacted by risk factors that affect the underlying asset classes.
Stocks are affected by market movements. Hence market risk is the single biggest risk factor affecting Equity Funds. International Equity Funds also face currency risk due to fluctuations in exchange rate. Equity funds are more prone to economic and industry risks since stocks are directly impacted by factors affecting the business and economic environment of a company.
Bonds are affected by interest rate changes since bonds are nothing but a kind of lending instruments. Thus, interest risk is the biggest risk factor affecting Debt Funds. Bonds are also subject to default and credit downgrades i.e the probability of a bond issuer failing to honour the payments under the bond or getting into a financial crisis that may cripple its ability to honour the bond payments. Hence debt funds face significant default and credit risk.
Both types of funds are prone to liquidity risk i.e the fund manager may find it difficult to sell some holdings from the portfolio if they are thinly traded or due to lack of demand for that security.