Debt MFs lost the indexation benefit in 2023. Interest from direct bonds is taxable at slab either way. Capital gains on listed bonds is now 12.5% LTCG after 12 months. On paper the tax treatment looks similar. So what does a debt MF still offer that a direct bond portfolio does not? Disc: genuinely asking, not trying to make a point.
Three things remain. First, liquidity. A debt MF can be redeemed at NAV any day. A corporate bond in the secondary market may have a thin bid at an unfavourable price. For money you might need in a hurry, that daily liquidity has real value. Second, diversification at small ticket size. A Rs 10,000 investment in a short duration fund gives you exposure to 50 issuers. The same amount in direct bonds gives you one issuer. Third, professional credit monitoring. A fund manager watches issuer health continuously. You do not.
okay but fund managers didn’t exactly catch DHFL before it blew up. and you pay expense ratio for that monitoring every year
Fair. The monitoring is imperfect and the expense ratio is a real cost, typically 0.3 to 0.5% annually on debt funds. Over five years that is 1.5 to 2.5% compounding against you. That is not trivial.
The practical split that makes sense for most investors: liquid and ultra short duration funds for money needed within one to two years. Direct bonds for the portion you are comfortable holding to maturity for two to five years. The fund buys you liquidity and diversification where you need it. The direct bond buys you yield certainty and no expense drag where you do not.
so it’s not either-or. funds for liquidity needs, direct bonds for locked returns. use both for different buckets
That is the right framework. The 2023 tax change removed the one advantage debt MFs had over direct bonds for long-horizon investors, which was indexation. But it did not change the liquidity advantage or the diversification advantage, which matter for the short-duration parking use case. Use the instrument that fits the purpose, not the one with the best headline yield.