Medium Duration Funds

Medium duration funds are open-ended debt mutual fund schemes that invest in debt and money market instruments with a Macaulay duration of the portfolio between 3 and 4 years. Macaulay duration is like the average wait time for all your money back from a bond, considering both interest payments and final repayment and helping you understand how sensitive the bond's price might be to interest rate changes.

This makes them an appealing option for investors seeking relatively stable returns with lower volatility than long-term debt funds. As of April 2024, this fund category has average assets under management (AUM) of Rs 25,788.15 crore with 15 schemes, the oldest being more than 26 years old, and the category ranked 12th in the list of open-ended debt funds according to the Association of Mutual Funds in India (AMFI).

Source: AMFI website as of April 2024

While you should identify your risk profile and plan your financial goals before investing in medium duration funds, here are some situations where they may fit in:

Alternative to Medium Tenor Bank Fixed Deposits

As of April 2024, medium duration funds offer attractive annual returns ranging from 5.54% to 8.20%. This outpaces large banks' 6.5-7% interest rates on comparable fixed deposits. While subject to market fluctuations, medium duration funds present a compelling opportunity to boost your returns compared to traditional banking products potentially.

Source: Valueresearch, SBI, HDFC Bank, ICICI Bank, BOB websites

Note: While medium duration funds are good alternatives to bank savings accounts and fixed deposits, they are not insured like them. Up to Rs. 5 lakh per bank account are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Moderate Risk Tolerance

Investors considering medium duration funds should have a moderate risk tolerance. While these funds offer potential for capital appreciation and income generation, they also carry interest rate and credit risk, which can lead to fluctuations in the fund's value.

Longer Investment Horizon

Medium duration funds may be more suitable for investors with a longer investment horizon who can withstand short-term market fluctuations. These funds may require patience as fund managers navigate changing market conditions.

Portfolio Diversification

Investors looking to diversify their portfolios beyond equities may include medium duration funds to spread risk. Investors with a lower risk tolerance who are uncomfortable with the volatility of stocks may find them more aligned with their risk preferences.

Dividend Taxation

These funds pay out dividends when you invest in their IDCW (Income Distribution Cum Withdrawal) option. Dividends are taxed at your marginal income tax rate, and TDS (Tax Deducted at Source) at 10% applies to dividends received more than Rs 5,000 per AMC per financial year.

Medium duration funds offer a range of benefits, as shown below.

Professional Management

These funds are managed by experienced fund managers who analyse market conditions, interest rate movements, and credit risks. Their expertise helps in making informed investment decisions to optimise returns. For example, SBI Magnum Medium Duration Fund is managed by Lokesh Mallya, who has 12 years of experience in fund management. (as of April 2024) 

Lower Volatility

Compared to equity mutual funds, medium duration funds tend to have lower volatility. They are generally less sensitive to market fluctuations, making them suitable for investors with a lower risk tolerance.

Diversification

Medium duration funds invest in a diversified portfolio of bonds issued by different companies and industries. This diversification helps spread risk and reduces the impact of poor performance from any single issuer. For example, ICICI Prudential Medium Term Bond Fund has invested in over 70 corporate’ bonds to diversify its investments (as of April 2024).

Accessibility for Retail Investors

Medium duration funds make it easier for individual investors to access the bond market, which may require a larger investment if buying individual bonds, whereas users can start investing in these funds for as low as Rs 100. This accessibility is beneficial for retail investors.

Balanced Risk and Return

Medium duration funds typically strike a balance between short-term and long-term bond funds. They offer a moderate level of interest rate risk compared to long-term funds and may provide higher yields than short-term funds.

Medium duration funds offer investors a balanced approach within the debt mutual fund category by targeting a portfolio with a Macaulay duration between 3 and 4 years. These funds provide relatively stable returns with lower volatility than long-term debt funds, making them suitable for investors with moderate risk tolerance and a longer investment horizon. While they offer advantages such as professional management, diversification, and potential for better returns compared to traditional fixed deposits, they also come with risks like interest rate sensitivity and market volatility. Understanding these aspects is crucial for aligning medium duration funds with your financial goals and risk profile, ensuring a well-rounded and diversified investment strategy.