Debt in equity funds? It’s not a red flag
It’s not dilution. It’s working capital. Here’s what most investors miss
You picked a pure equity mutual fund. Naturally, you expect 100% of your money to be invested in stocks.
But then you open the fund’s factsheet and see something odd: a small part of the portfolio sometimes 2%, sometimes 7–8% is parked in debt instruments.
Wait a second.
Isn’t this supposed to be an equity fund?
It is. And it’s completely normal.
Before we go further, Why this matters
It helps to build a broader understanding.
Here’s why:
Even a tiny event inside or outside the market can be interpreted in countless ways. All those opinions create confusion. Confusion turns into uncertainty. And uncertainty almost always leads to emotional decisions.
When you feel unsure, doing nothing feels like the wrong choice. It feels like everyone else is taking action while you’re frozen. So you start believing that any action will bring relief.
But in investing, not reacting when it isn’t necessary is often harder and much more effective than acting impulsively.
One rash decision, taken in panic or under someone else’s influence, can undo years of steady progress.
That’s why I try to explain these events clearly so you can interpret them in your own way, without fear.
Why Does an Equity Fund Hold Debt?
Let’s unpack this.
Every mutual fund even the most aggressive equity fund has to balance growth with flexibility. Debt instruments (like T-Bills, short-term bonds, or overnight funds) aren’t there to generate big returns. They’re there to make the fund work smoothly.
They act as:
A shock absorber
A cash cushion
A timing tool
All rolled into one.
Four simple reasons this happens
1. Liquidity Management
Redemptions don’t come with an appointment. Investors can redeem their units at any time even during a market dip.
To avoid panic-selling stocks to pay them back, the fund manager keeps some money in short-term debt. This way, they can:
Meet redemption requests calmly
Avoid dumping stocks at bad prices
Gradually invest fresh SIP money
This is why you’ll sometimes see your NAV falling even if the manager hasn’t fully deployed your money in equities yet. It’s not underperformance it’s deliberate.
2. Regulatory Flexibility
SEBI rules are clear: for a fund to be called an equity fund, at least 65% must be in equities. That means up to 35% can legally be in debt or cash.
Most funds stay around 90–98% equities. The small debt portion simply keeps the fund compliant and prepared. It doesn’t dilute the strategy.
3. Tactical cushion
Sometimes the market is volatile or valuations are stretched. Maybe earnings season is around the corner. Rather than buying stocks immediately, managers may park money in debt for a few days or weeks.
This isn’t about timing the market it’s about sticking to their philosophy and waiting for the right opportunities.
4. Uninvested dividends or cash
When the fund gets dividends or exits a stock, that cash doesn’t always get deployed the same day. It usually sits in liquid debt instruments for a short while. This is just smart housekeeping not a shift in strategy.
Should you worry?
In most cases, absolutely not.
A small debt holding:
Doesn’t hurt your long-term returns
Doesn’t change your equity exposure meaningfully
Doesn’t signal poor management
However, you should pause and look deeper if:
The debt or cash portion is consistently over 15%
The factsheet or commentary offers no clear explanation
The fund starts behaving differently from its stated approach
Bottom line
Even aggressive equity funds keep some debt on hand not to chase returns, but to manage money responsibly. It’s not a red flag. It’s a sign that the fund is operating in the real world, not just on a spreadsheet.
So the next time you see “5% in debt” in your factsheet, don’t panic. Don’t overthink. Just remember:
It’s not weakness. It’s working capital.
Coming up in future posts
How to read a fund factsheet without needing a finance degree
Why some funds hold cash for long periods (and when that’s a red flag)
How to tell if your fund is sticking to its philosophy or drifting
Why fund managers often get blamed for things beyond their control
What your fund’s “cash call” really means
Stay tuned. Let’s keep making mutual fund investing simpler, calmer, and more confident.