Medium Duration Funds are debt funds with 3-4 years of investment horizon.
Investors looking to invest for at least 3 years can park their money in Medium Duration Funds. These funds can cater to your financial goals like buying a property, planning your child’s higher education abroad, or any significant expense happening within 3-4 years.
These funds can be an alternative to fixed deposits as they deliver superior returns.
Read along to know more about Medium Duration Debt Funds.
How Do Medium Duration Funds Work?
To create a Medium Duration scheme, fund managers distribute assets among debt and money market securities provided the Macaulay Duration is 3-4 years.
What Is Macaulay Duration?
It is the weighted average number of years the present value of a fixed income instrument’s cash flows will take to match the amount paid for the instrument.
In simple words, Macaulay duration means the average time you will need to recover the initial investment through the instrument’s cash flow.
Please note that- in this case, duration does not mean tenure. Duration measures the value/sensitivity of the principal amount with respect to a change in interest rate. And tenure indicates maturity.
If the Macaulay duration is higher-> the instrument’s sensitivity to the changing interest rate is also higher.
These funds have higher maturity than Short Duration, Low Duration, Ultra Short Duration, and Liquid funds. And lower maturity than Medium-to-Long and Long Duration Funds.
Investors with moderate risk appetite can invest in these funds instead of bank FD.
Top 4 Advantages of Medium Duration Funds
1. Superior Returns
These funds have the potential to deliver superior returns than short-term debt funds and even FDs.
Due to a slightly longer investment horizon, returns are subject to change in the interest rate cycle. These funds perform well, especially during falling interest rates.
2. Portfolio Rebalancing
Medium Duration funds can balance the risk of equity mutual funds. The equity market is often volatile. A lot of factors affect the market.
Debt funds are comparatively safer and more stable. Investors can rely on these funds to keep their portfolios balanced against other investments with similar horizons.
3. Fixed Deposit Alternative
FDs are popular because of their security and guaranteed fixed returns. However, these returns may not be satisfying during falling interest rate scenarios. In that case, Medium Duration funds can replace FDs.
4. Liquidity
Medium Duration Funds offer better liquidity than Long Duration debt funds. 3 to 4 years is a good enough horizon to earn superior returns and achieve your financial goal.
Though if you are looking for an even shorter horizon, go for liquid funds, Ultra Short Duration, Low Duration, Short Duration funds.
Things to Consider Before Investing
1. Risk
Debt funds come across interest rate risk and credit risk.
In the case of Medium Duration funds, a rising interest rate scenario is not ideal. It can lower the NAV of the funds, thereby reducing your returns. Though if you hold till maturity, the risk can be mitigated.
Credit risk occurs when the underlying assets have low credit quality. Though fund houses often maintain high credit quality.
You can check the fund scheme to understand the underlying assets and their credit quality.
2. Investment Horizon
Each investor has different money goals, risk appetite, and expectations. For some investors, 3-4 years can be a short-term goal, whereas others might think it’s too long.
It depends on what you are comfortable with. Make sure the investment horizon of Medium Duration Funds aligns with your preferred horizon.
3. Your Investment Goals
Debt funds can serve multiple purposes. You can rely on debt funds for risk balancing. Or for fulfilling a specific goal like buying a car.
Among the 15 Types of debt funds, you’ll find a specific scheme for each of your short or long-term goals.
Analyze your investment goals to decide when and how much you should invest in Medium Duration Funds.
4. Modified Duration (MOD) of the Fund
In the case of Medium to Long Duration Debt Funds, the Modified Duration (MOD) plays a vital role.
Modified duration measures the change in the value of a bond in response to a change in 100-basis-point (1%) change in interest rates.
During the falling interest rate scenario, with each 1% fall, the NAV of the funds goes up by MOD%. If the Modified duration is 6, then the NAV will go up by 6% every time the interest rate falls by 1%.
NOTE: In reality, the interest rate rarely actually falls by exactly 1% in one go. The calculations will modify based on the actual fall in the interest rate.
Tax Implications
As per new tax rules on debt funds applicable since April 2023: Both Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG) will be taxed as per your tax slab.
Investors will no longer benefit from indexation on Long-Term Capital Gains.
Who Should Invest in Medium Duration Funds?
Medium Duration funds are ideal for investors who want better returns than fixed deposits but don’t want the risk of equity markets.
Investors who want to balance their equity portfolio can also bring these funds on board. We’d recommend evaluating your existing portfolio to make sure these funds align with your goals. And as said earlier, you’d earn more returns if you invest during the falling interest rate scenario.
Conclusion
Medium Duration Debt Fund can be a game changer if you invest at the right time with the right goal. Your financial goals for the next 3-4 years can be strengthened with these funds.
If you are not a fan of FD, park your money in Medium Duration funds. Not only will you earn superior returns but also achieve portfolio balance.
However, as mentioned above, these funds are more suitable during a falling interest rate scenario. To know more about the effect of current repo rates on debt funds, get in touch with our advisors. We will help you align your portfolio with the suitable type of debt fund.