Low Duration Debt Funds – Definition, Benefits and Should You Invest in Them
Last Updated : July 3, 2020, 6:17 p.m.
Debt funds invest in debt securities such as corporate bonds, money market instruments, commercial paper, certificate of deposit, treasury bills and government securities. Different types of debt funds invest for varying maturities or duration of these securities. So, there could be a debt fund investing in securities maturing in a day, month, year, three years and more.
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Categories of debt funds are classified based on their maturity profile and the type of securities they buy in the portfolio. Low duration funds are a type of debt fund. Let us understand more about it.
What are Low Duration Debt Funds?
Low duration funds are open-ended debt funds that invest in debt securities with a duration between six to twelve months. For simplicity, you can assume duration to be the period in which the debt security will fully mature and return all coupons or interest payments.
The objective of these funds is to deliver better returns than liquid funds by taking a call on interest rate movements in the short-term. Thus, these funds do have interest rate risk, but it is much lesser than short-term, medium duration, long duration and gilt funds. These funds do well in a falling interest rate scenario and can outperform liquid funds by 1.50-3.00%. So, one can expect returns between 7-9% from these funds.
Like all other funds, these funds have their own benefits. Let us understand them.
Benefits of Investing in Low Duration Funds
Returns – You can expect better returns from these funds when compared to liquid funds. They can deliver 2-3% greater returns compared to liquid funds, especially in a falling interest rate scenario.
Volatility – Among all debt funds that have some interest rate or credit risk, these funds are the least volatile. As the duration profile of a fund increases, the volatility also increases. Thus, short-term medium term, long duration and gilt funds are more volatile than low duration funds.
Risk – If you are willing to take a slight risk in debt funds for higher returns, low duration funds are the ones with the lowest risk among all kinds of duration funds.
Should You Invest in Low Duration Funds?
Low duration funds are suitable for people who are looking to invest with a time horizon of 6-12 months and are aiming for higher returns than liquid funds. If you want your debt investment to be completely risk-free, you should invest in overnight or liquid funds only.
However, if you are looking for that extra 2-3% over liquid funds with low risk than other duration funds, you can invest in low duration funds. Please note if you withdraw before a year from a debt fund, the STCG (short term capital gain tax) is applicable which is basis a person’s tax slab.
So, you should calculate the post-tax return before investing. If the low duration fund you invest in gives you an 8% return and if you are in the 20% tax bracket, the net returns post-tax will be 6.40%. This return is higher than savings bank accounts, fixed deposits and liquid funds.
We recommend investing in low duration funds in the current scenario if you are looking for a debt fund that beats liquid fund returns. Interest rates have fallen drastically in the last year and should fall further in the next six months owing to a slowing GDP growth. In such a scenario, low duration funds will do well.
To know the best five low duration funds to invest in, you can read another post of ours-Five Best Performing Low Duration Debt Funds.