Why do Debt Funds offer lower returns as compared to Equity Mutual Funds?

Returns from Mutual Funds depend on the kind of investment it makes, and the risks associated with these investments. The taste of a cake differs from that of a samosa because both are made up of different ingredients and are prepared differently. Similarly, equity mutual funds and Fixed Income Funds offer different kinds of returns because of the kind of securities that make up their portfolio and the way these securities generate their returns.

Fixed income funds invest in interest paying securities like bonds, debentures and money market instruments. These securities promise to pay a fixed interest at regular intervals to these Mutual Funds. The rate is closely linked to the prevailing lending rates in the market. Since the issuers of these securities may fail to fulfill their promise, they promise to pay higher periodic interest than current lending rates as a compensation for the risk in such investments. A well-established corporate is likely to offer lower interest (lower risk premium) on its bonds as compared to a rookie company because its bonds carry a higher credit rating than the newer firm.

Returns from an investment are directly linked to the risk involved. Usually, debt securities are considered less risky than equities. Thus, lower risk investments like fixed income funds will offer lower returns unlike equity funds