The financial market offers many investment options, which can be overwhelming. Understanding each investment vehicle’s unique features, benefits, and risks is essential to making informed decisions.
One option that’s often discussed is Medium to Long Duration Funds. What are they? How do they work? And are they right for you? This article provides a comprehensive guide to Medium to Long Duration Funds to answer these questions.
What are Medium to Long Duration Funds?
Mutual debt funds categorized as Medium to Long Duration Funds invest in money market instruments and debt with a Macaulay portfolio duration from 4 to 7 years.
The Macaulay duration measures the average time until receiving a bond’s cash flows. This duration offers insight into the bond cash-flow timing and how long it takes to regain the invested amount.
The primary objective of these funds is to generate returns from the interest income of debt instruments and potential appreciation in their value due to changes in market interest rates.
How do Medium to Long Duration Funds work?
The working of Medium to Long Duration Funds is based on the concept of interest rate risk and duration. When interest rates in the economy rise, the prices of existing bonds with lower interest rates fall, and vice versa. This inverse relationship between interest rates and bond prices is the fundamental principle these funds operate on.
The fund manager of a Medium to Long Duration Fund actively manages the portfolio by adjusting the duration based on their interest rate outlook.
If the fund manager expects interest rates to fall, they may increase the fund’s duration to benefit from the potential rise in bond prices. Conversely, if interest rates are expected to rise, the fund manager may decrease the time to minimize the impact of falling bond prices.
| Interest Rate Change | Effect on Existing Bond Prices | Fund Manager’s Action |
| Goes Up | Bond prices with lower rates drop | Decrease fund’s duration to minimize the impact of falling bond prices |
| Goes Down | Bond prices with lower rates rise | Increase fund’s duration to benefit from the potential rise in bond prices |
Who should invest in Medium to Long Duration Funds?
If you:
- Plan to invest for 4-7 years
- Are okay with moderate to high risks
- Want both regular income and potential capital growth
- Understand how interest rate changes affect bond prices
Then, Medium to Long Duration Funds might be your thing.
Factors to consider before investing in Medium to Long Duration Funds in India
Risks
Funds with a medium to long duration come with risks related to interest rates and credit risks. Changes in these factors can cause the fund’s value to fluctuate, affecting its net asset value (NAV). This happens when the credit quality of the securities underlying the fund changes or when there are changes in interest rates.
Returns
The returns from these funds are not fixed and depend on the interest income from the underlying securities and the changes in their market prices.
Expense Ratio
The expense ratio is the cost of managing the fund, which can affect the net returns. A lower expense ratio can result in higher net returns. So, choosing a fund with higher expense ratios can eat into your returns.
Investment Plan
It can be an excellent choice if you’re searching for an investment option with a preferred investment period of 4-7 years. This is especially true if you’re planning for a significant expense like a wedding, buying a house, or a luxury car, where you need safe and somewhat better returns than other debt instruments.
Taxation on Medium to Long Duration Funds
Medium to Long-duration funds are taxed just like any other fund. Most of their allocation is towards debt instruments, meaning that investments’ gains are subject to taxation based on your income bracket and the tax slab you fall into.
For example, if you made Rs. 1000 in returns on your debt investment and are in the 30% tax bracket, your debt investment would be taxed at 30%, leaving you with a net profit of Rs. 700 after taxation.
Note: Medium to Long-duration funds and other debt funds don’t attract long-term capital gains tax, as they aren’t considered equity investments. It’s crucial to understand that only funds with over 35% equity exposure qualify for long-term capital gains tax benefits, per new tax laws.
Conclusion
If you’re looking to invest for the medium to long-term and don’t mind taking on moderate to high risk, Medium to Long Duration Funds could be a wise choice to add to your portfolio.
These funds offer the potential for higher returns than traditional long-term investments but keep in mind that they are subject to market risks, and factors like changes in interest rates and credit quality of underlying securities can impact their performance.
Before investing, it’s essential to fully comprehend these funds and consider your investment goals, risk tolerance, and investment timeline.
Medium to Long Duration Funds: Frequently Asked Questions (FAQs)
1.What is the Macaulay duration?
Macaulay duration is like a clock that tells you when you can expect to return most of your investment from a bond or bond fund. It’s a way of figuring out how long it will take to regain your investment, considering both the regular interest payments you receive and the final repayment at the end of the bond’s term.
2.What are the risks associated with Medium to Long Duration Funds?
Like any investment, these funds come with their own risks. The main ones are changes in interest rates and the possibility of a company being unable to pay back its debt (credit risk).
3.Who should invest in Medium to Long Duration Funds?
If you don’t need to use your investment money for a while(4-7 years), and you’re okay with taking on some risk to get higher returns, these funds could be a good fit. It’s important to understand that bond prices can increase and decrease with interest rate changes.
4.How do Medium to Long Duration Funds compare to other long-duration investment options?
Unlike long-term investments like fixed deposits, the returns from these funds aren’t set in stone and can change with market conditions. However, the upside is that they have the potential to give you higher returns compared to traditional long-term investments.
5.Can I sell my investment in long-term bond funds whenever I want?
Yes, you can sell your investment in a bond fund anytime. However, the price you get will depend on the current market conditions. If interest rates have gone up since you bought the fund, the value of your investment might have gone down.