Medium to Long Duration Debt Funds

As the name suggests, Medium to Long Duration Debt Funds are built for investors with a medium to long-term investment horizon. While these funds hold the potential to generate higher returns, they are also exposed to credit and interest rate risk. Let’s look at the top medium to long duration mutual funds, how they work and how you can choose one for yourself.

What are Medium to Long Duration Debt Mutual Funds?

Medium to long duration mutual funds are debt mutual funds that invest in bonds with an average maturity of 4 to 7 years. Bonds are essentially issued by corporations or the government to borrow money. When you invest in a bond you are lending money to the bond issuer for a fixed period. In return, the issuer promises to repay the principal amount at the end of the term with interest paid at regular intervals.

This means that when you invest in a medium to long duration fund your fund manager is deploying your investment in bonds that mature within 4 to 7 years. The primary objective of a medium to long duration fund is to earn through capital appreciation and interest income. However, due to the extended maturity, they are also at a higher risk exposure to interest rate risk and credit risk. 

Best Medium to Long Duration Funds

List of the top-performing medium to long duration mutual funds sorted by returns with their AUM and Expense Ratio.

Should I invest in a Medium to Long Duration Mutual Fund?

Debt mutual funds are a safer investment choice than equity mutual funds. However, depending on the fund, these funds have certain characteristics that may not suit you as an investor. 

To assess, you should consider the following factors before investing in medium to long duration mutual funds: 

1. Consider your investment horizon

Before making any investment choice, ask yourself how long you wish to stay invested. Medium to long duration funds take 4 to 7 years to mature. Say, you plan to invest in a fund and expect it to generate returns within 2-4 years then these funds may not be the right fit.

2. Asses your risk profile

Are you a conservative or aggressive investor? Medium to long duration debt funds are not stray from risk. Since the Macaulay (maturity) duration of these funds are longer, the returns are at a risk of getting affected by credit risk and  interest rate risk. This means that during this period, the fund's NAV could decline due to interest rate changes or due to a fall in the credit rating of the bond issuers. 

3. Know your investment objective

Having a clear understanding about your investment objective is crucial. You should know what sort of returns are you really expecting. For example, Medium to long duration funds have given an average annual return of 6.12% over the last 5 years If this matches your return expectation, they are a suitable investment. At the same time, these funds enjoy less risk than an equity fund.

How do I select a Medium to Long Duration fund?

While picking a debt mutual fund you need to run certain checks to ensure you are selecting a fund that aligns with your investment goals. These include:

1. Measure Risks

Every debt mutual fund stands at the risk of getting affected by two major risks:

• Credit risk: Credit risk is when a borrower defaults in paying the loans. Debt mutual funds invest in bonds. These bonds are issued on the basis of a promise to repay the loan within a stipulated period. If during this period, the company faces financial challenges and cannot pay back the principal or interest, then the mutual fund NAV is negatively impacted. This is known as credit risk.
• 
  Interest rate risk: Interest rates and bonds have an inverse relationship. Interest rates in the market fluctuate on the basis of economic conditions. If interest rate increases, new bonds with higher interest rates will surface making the current bond less attractive, hence the NAV of the debt mutual fund could drop. Conversely, if the interest rate decreases, current debt funds benefit from an increase in value.

When you pick medium to long duration funds understand that they can be affected by these risks. Check that the bonds your mutual funds invest in have a good credit rating. This ensures to some extent that the probability of making a loss is less.

2. Check Portfolio Allocation

Your mutual fund’s portfolio should have a healthy balance between different types of debt and money market securities. If it is heavily invested in corporate bonds, it's a problem. Usually, a healthy mix of Government bonds ensure that there is less probability of default.

3. Analyse Key Metrics

Apart from the above checks, you also need to check other metrics like ‘yield-'to-maturity’ and 'average maturity'.

We’ve discussed how you can pick a debt mutual fund in further detail here.

What will be my tax liability with a Medium to Long Duration fund?

Any gain from the sale of your debt mutual fund is liable to tax. However, your tax liability varies based on when you purchase these bonds and when you sell them. If you sell a debt mutual fund within 24 months it is considered a short-term capital gain (STCG). 

Similarly, if you sell a debt mutual fund after 24 months it is considered a long-term capital gain (LTCG). Your tax liability in both these cases varies. Learn your tax implications for debt mutual funds here.