Medium Duration Funds

Debt mutual funds offer a range of choices for conservative investors. For those seeking low-risk options, funds with shorter or medium maturity periods are often ideal as they carry a lower interest rate risk, making them a safer bet. In this article, let’s explore what medium-duration debt funds offer, their key characteristics and who should invest in them. 

What Is Medium Duration Mutual Fund?

Medium-duration mutual funds invest in debt instruments such as bonds and fixed-income securities, with a maturity period of 3 to 4 years. These funds strike a balance between short-term and long-term investments as they offer the benefits of higher returns compared to short-term funds at a relatively lower interest rate risk than long-term funds.

The key feature of medium-duration mutual funds is their Macaulay Duration, which is maintained between three and four years. This duration represents the weighted average time to receive the fund’s cash flows. 

Medium-duration funds are suitable for moderate risk-taking investors, seeking steady returns, capital appreciation, and lower volatility than long-term funds. 

Features of Medium Duration Mutual Funds

Here are the key characteristics of a medium-duration fund:

Maturity: These funds are a subset of debt funds with the average maturity of the underlying securities of around 3 to 4 years.

Risk & Return: These funds offer higher returns than short-term funds since they have a slightly longer duration, but carry lower risk than long-duration funds, making them ideal for investors with a moderate risk appetite.

Liquidity: Medium-duration funds offer better liquidity than long-term funds, allowing investors to access their money more quickly when needed.

Diversification: These funds spread investments across various debt instruments to reduce risk through diversification.

How Do Medium Duration Funds Work?

Medium-duration mutual funds pool money from multiple investors which they invest in a range of debt securities to spread risk. They invest across different types of bonds and money-market instruments like government bonds, corporate bonds, treasury bills etc. 

These funds primarily earn returns from the interest income generated by the fixed-income securities they hold. This makes the fund manager’s job quite important. The fund manager actively monitors and adjusts the fund’s holdings based on current market conditions and interest rate forecasts. Through this active management, the fund manager aims to optimise returns while keeping risk in check.

Advantages of Investing in Medium Duration Mutual Funds

Medium-duration mutual funds have many advantages, such as:

Steady Income Stream: Medium-duration debt funds generate regular income through interest from debt securities, making them an attractive option for investors seeking consistent returns.

Balanced Risk and Return: These funds provide a balanced risk-reward to investors by offering higher returns than short-term funds while managing interest rate risk better than long-term investments.

Diversification: These funds invest in a wide range of debt instruments and money market securities, which helps spread risk and improve the portfolio performance. 

Liquidity: Since a medium-duration fund invests in securities that mature within 3-4 years, it offers relatively good liquidity. Investors can access their money more quickly than other long-term investment options.

Risks Associated with Medium Duration Funds

Medium-duration debt funds are vulnerable to the following risks:

Interest Rate Risk: Being part of the debt fund category, a medium-duration fund is exposed to interest rate risks. However, the extent of risk depends on the investment’s duration. In the case of medium-duration funds, the risk is higher than short-term funds.

Credit Risk: Credit risk is the risk of default on the issuer's part. If the fund has invested in lower-rated instruments, it exposes them to possible credit risk. 

Inflation Risk: Returns from medium-duration funds might not always beat inflation over the long term. The average returns by these funds are 7-9%, resulting in low real returns when inflation is on the higher side. 

Who Should Invest in Medium Duration Mutual Funds?

A medium-duration fund is suitable for the following investors:

Moderate Risk Appetite: These funds are suitable for investors with a moderate risk appetite as they offer a middle ground between low-risk short-term funds and higher-risk long-term funds.

Medium-Term Investment Horizon: If you have an investment horizon of about 3 to 4 years, these funds are suitable as they align with this medium-term timeframe. These funds are ideal for investment goals like purchasing a home, marriage, education of children etc.

Balanced Investors: If you’re looking for a mix of steady income and moderate growth, then a medium-duration fund can be your go-to choice.

Diversification Seekers: Investors who want to diversify into other asset classes beyond equities can look to include medium-duration funds. These funds are a lower-risk option and more suitable for those who are easily spooked by market volatility.

Factors to Consider Before Investing in Medium Duration Funds

Before investing in a medium-duration mutual fund, consider these key factors:

Investment Horizon: Make sure the fund’s average maturity aligns with the duration you’re planning to invest.

Risk Tolerance: Medium-duration funds offer a balanced risk-reward profile but are not risk-free. They are susceptible to interest rate risk and credit risk. Therefore, it's crucial to analyse the fund’s risk level. 

Historical Performance: Analyse the fund’s historical performance against the benchmark and other funds in the category to gauge possible returns.

Expense Ratios: Expense ratio is the annual fee charged by a fund house for managing the fund. Check the fund’s expense ratio, and compare it with other funds in the category to find the most cost-efficient option.

Fund Manager’s Experience: Research the fund manager’s track record. A skilled manager can effectively handle market fluctuations which can impact performance.

Taxation Rules for Medium Duration Funds

Medium-duration funds can offer attractive returns, but understanding their tax implications is crucial. For investments made on or after April 1, 2023, gains from these funds will be added to your income and taxed at the applicable income tax slab rate. For investments made before April 1, 2023, the tax implication is as follows:

Short-Term Capital Gains Tax (STCG)  

If you hold your medium-duration funds for less than 24 months, the gains are classified as short-term capital gains and are taxed according to your income tax slab.

Long-Term Capital Gains Tax (LTCG)

If you hold your medium-duration mutual funds for over 24 months, the gains are categorised as long-term capital gains and are taxed at 12.5% without indexation.

How To Invest in Medium Duration Funds?

Investors can invest in the best Medium Duration Funds directly through the AMC platform or via INDmoney app. To invest through INDmoney, you can follow these steps:

• Open the INDmoney app and log in with your credentials.
• Go to the "Mutual Funds" section.
• Use the filter to choose "Medium Duration Funds" and view the available options.
• Choose between making a lump sum investment or setting up a Systematic Investment Plan (SIP) for regular contributions.
• Enter the amount you wish to invest and confirm your transaction.