Debt funds are a secure investment option which focus on securities offering fixed income. However, there are many kinds of debt funds categorised on the basis of their maturity. One among them are low duration funds. 

 

Debt funds have a relatively longer maturity than liquid funds but less than that of short term and medium term debt funds.


Thus, they are riskier than certain debt funds but carry less volatility overall as they completely cut out any equity or stock. Read on to learn more about low duration mutual funds, how they work, factors to consider and more.

What are Low Duration Debt Funds?

Low duration funds are debt and money market instruments with Macaulay duration between 6 and 12 months as per the Securities and Exchange Board of India (SEBI) guidelines. They specifically choose securities keeping in mind this Macaulay Duration for investors looking at a 1-year maturity at maximum. 

 

While they carry a slightly higher interest rate risk due to this, they invest in short-term money market instruments, government and corporate bonds. This is why they are safer.

How is Risk Measured When it Comes to Low Duration Mutual Funds?

Investment in low duration mutual funds works on the concept of duration. Shorter durations have low sensitivity to interest rate changes and vice versa. Since low duration funds invest in short-term fixed income securities and bonds, their risk profile is lower. 

 

Thus, investing in low duration funds could be beneficial if you are looking to lower your exposure to risk.


Moreover, there is no restriction on the type of asset low duration debt funds can invest in, as per SEBI. So, permitted derivatives, securitised debt and more can form a part of such schemes as long as the duration of 6-12 months is maintained.

Pros of Low Duration Funds

Investing in low duration funds comes with various benefits. Here are some to know about:

  • Higher Returns

Low duration funds have the potential to provide high returns. This is because low duration funds are debt funds with short duration. They generate returns in the 6 to 12 months period and get evaluated on the basis of their performance.

 

They typically outperform liquid funds in terms of returns since they get greater exposure to credit and for longer. Additionally, they have the potential to provide greater returns than ultra-short duration funds as well. This is because by holding longer maturity bonds, they can generate greater capital gains.

  • Less Volatility

Another benefit of investing in low duration mutual funds is that they are associated with less volatility. When compared to various types of debt funds, low duration mutual funds are the least volatile.

 

This is primarily due to the shorter duration. With the increase in the investment duration of a fund, the volatility of the fund increases. Therefore, low duration funds have a lower degree of volatility as compared to short term, medium term, long term, and other types of funds.

  • Moderate Risk

Low duration mutual funds have a moderate level of risk associated with them since the investment duration is short. With a fall in interest rates, the loss of interest income on new bonds is comparatively lesser as compared to capital gains on existing bonds.

 

On the other hand, with an increase in interest rates, the funds lower the duration to minimise capital losses, while getting higher interest rates on new bonds. Therefore, when compared to funds with a longer duration, low duration funds are less volatile.

Cons of Low Duration Funds

Like every investment option, low duration funds have some drawbacks as well.

  • Credit Risk

Credit risk refers to the risk of default on the bonds held in the fund. Low duration funds carry a higher credit risk than liquid funds. To lower the impact of this type of risk, evaluate the portfolio in terms of the credit quality of the holdings of the fund and compare it with your risk tolerance.

 

This is because a greater proportion of the assets of a low duration fund can get invested in lower-rated debt, which comes with a higher risk of default.

  • Interest Risk

Low duration funds also have a higher interest rate risk, which is the risk of loss because of changes in interest rates. Low duration funds have moderate interest rate risk since they come with a shorter investment period.

 

To steer clear of this risk, you must track the fund’s duration, which gets published every month. The changes in duration indicate if the fund’s interest rate risk is increased.

How to Plan Your Investment and Choose Low-Duration Mutual Funds

Choosing the right investment that aligns with your investment goals and risk appetite is crucial. Here are some essential points that can help you choose a suitable low duration mutual fund.

  • Know the Risks

Just like other debt mutual fund schemes, low duration debt funds also come with liquidity, credit and interest rate risks. So, assess the focus area of investment to see if the scheme balances bonds that are rated low with those that mature faster.

  • Have Clear Investment Goals

Make sure that you think about why you are investing and what your choices are based on. Since low duration funds are comparable to savings accounts and deposits, invest as per your needs, timeline and preferences. 

  • Optimise for Higher Returns

Fund house charges certain fees to manage the scheme and take appropriate action based on market performance. Check the expense ratio to ensure your gains are well worth it.

  • Performance History of the Funds

Consider the benchmark rates, past performance, fund manager’s experience and credit ratings of the portfolio. All this can help you make better choices about which scheme to go with.

Who Should Consider Investing in Low-Duration Debt Funds?

You can consider investing in low duration mutual funds as a way to park your funds briefly and benefit from an open-ended scheme. Better liquidity and higher returns as compared to traditional investment options are why investors usually choose these schemes.

Taxation of Low-Duration Funds

When you invest in low duration funds, you will need to pay taxes on any dividend income you earn. This is as per your IT slab rates. In addition, short term capital gains are also taxed as per the slab and debt funds no longer offer indexation benefits. 


With this information, you can make your decision smartly and even choose the right low duration debt fund. Once you have clear financial goals in mind, invest in a scheme of your choice on Bajaj Markets. With numerous top-performing funds, you can secure your financial growth in just a few clicks.

FAQs on Low-Duration Mutual Funds

What are the benefits of a low-duration fund?

Investing in low duration funds comes with low risk and offers higher returns as compared to traditional risk-free investments.

Are low duration funds safe?

Since low duration funds invest in debt securities, they are considered a safer investment. However, they also carry the risk that all debt funds share such as liquidity risk, interest rate risk and credit risk.

What is the credit quality and type of assets that low duration funds invest in?

There is no defined type of security or bond that low duration mutual funds are limited to. As per SEBI rules, such schemes only lend between a 6-to-12-month period.

What is the difference between low duration and short duration funds?

Low duration funds and short duration funds differentiate in terms of their Macaulay Duration. Short duration debt funds are held for 1-3 years while low duration funds are held for 6 to 12 months.

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