Medium To Long Duration Funds

Medium to long duration Funds are open-ended debt mutual fund schemes that invest debt and money market instruments with a Macaulay duration of the portfolio between 4-7 years. Macaulay duration is like an average wait time for all your money back from a bond, considering both interest payments and final repayment, and helps you understand how sensitive the bond's price might be to interest rate changes.

They are suitable for investors who have a longer investment horizon and are willing to tolerate potential fluctuations in bond prices. As of February 29, 2024, this fund category has assets under management (AUM) of Rs 110,528.85 crore with 12 schemes with the oldest being 29 years old, and the category ranked 15th in the list of open-ended debt funds according to the Association of Mutual Funds in India (AMFI).

Source: AMFI website as of February 29, 2024

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

Alternative to Medium to Long Tenor Bank Fixed Deposits

As of February 19, 2024, medium to long duration funds offer annual returns between 7.6% and 9%. This outpaces the 6.5-7% interest rates offered by large banks on comparable fixed deposits. While market fluctuations can impact returns, these mutual funds generally provide a better opportunity for growth than traditional bank fixed deposits.

Source: Valueresearch, SBI, HDFC Bank, ICICI Bank, BOB websites as of February 19, 2024

Note: While medium to long 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).

Decreasing Interest Rate Outlook

These funds may perform well in a falling interest-rate environment. When interest rates decline, the prices of existing bonds in the fund's portfolio may increase, resulting in capital gains.

Moderate Risk Tolerance

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

Longer Investment Horizon:

Medium to long 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 to long duration funds to spread risk. Investors with a lower risk tolerance who are uncomfortable with the volatility associated with stocks may find them more in line 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.

Professional Management

These funds are managed by experienced professionals who use market analysis, interest rate tracking, and credit risk assessment to maximize returns. For example, ICICI Prudential Bond Fund is managed by Manish Banthia who has 13 years of experience in fund management (as of April 29, 2024).

Lower Volatility

Compared to equity mutual funds, medium to long 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 to long 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, Aditya Birla Sun Life Income Fund has invested in more than 50 corporate and government bonds to diversify its investments (as of April 29, 2024).

Accessibility for Retail Investors

Medium to long 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 with as low as Rs 100. This accessibility is beneficial for retail investors.

Potential for Capital Appreciation

Beyond the regular income, investors may also experience capital appreciation if the value of the underlying bonds increases due to factors like declining interest rates or improving the creditworthiness of issuers.

Rising Interest Rate Scenario

Medium to long duration funds are sensitive to changes in interest rates. When interest rates rise, the prices of existing bonds tend to fall. Conversely, when rates decline, bond prices may rise. Investors in medium to long duration funds may face capital losses if interest rates move unfavorably.

Market Risk

Medium to long duration funds invest in a mix of debt securities, and their performance is influenced by market conditions. Economic factors, credit risk, and overall market volatility can impact the fund's returns.

Credit Risk

Medium to long duration funds may invest in bonds with varying credit qualities. A downgrade in the credit rating of the bonds in the portfolio could lead to losses.

Inflation Risk

Inflation can erode the purchasing power of fixed-income investments. If inflation rises unexpectedly, the real returns from medium to long duration funds may be diminished.

Liquidity Risk

Some medium to long duration funds may invest in less liquid or harder-to-trade securities. In times of market stress, selling such securities may be challenging, potentially impacting the fund's ability to meet redemption requests.

Complexity and Duration Risk

Understanding the dynamics of medium to long duration funds, including their duration, requires a certain level of financial literacy. Investors who are not familiar with these complexities may find it challenging to assess and manage their investments effectively.

Medium to Long Duration funds offer Indian investors a way to add fixed-income investments to their portfolios, with the potential for greater returns than short-term debt funds or bank fixed deposits. However, they're not without risk, and are best suited for those with a moderate risk tolerance and a moderately long investment time frame. Before investing, weigh the potential returns alongside your understanding of interest rate sensitivity and credit risk to ensure these funds fit your financial goals.