Medium Duration Funds: Steady growth for your mid-term goals

In 2018, SEBI rolled out 16 types of debt mutual funds, and one of them are the Medium Duration Funds. If you've been considering an investment for a span of 3-4 years, this might be an avenue worth exploring.

These funds strike a balance between risk and return over a medium-term investment horizon. This article will dive into the concept of Medium Duration Funds, how they operate, and crucial considerations to bear in mind before investing in them.

What are Medium Duration Funds?

Funds under the Medium Duration category primarily focus on investing in debt and money market instruments. These funds are designed to have a portfolio Macaulay duration that typically ranges between 3 to 4 years. The term Macaulay duration might sound technical, but it's essentially a measure indicating the average time until a bond's cash flows come back to the investor. Think of it as the recommended time you should ideally remain invested in a fund to maximize benefits and minimize risks.

How do Medium Duration Funds work?

Medium Duration Funds are investment vehicles that pool together a variety of debt and money market instruments, such as bonds and short-term securities, which typically mature in 3 to 4 years.  These funds are managed by experienced professionals, also known as fund managers, who make informed decisions on the selection of instruments based on factors such as prevailing interest rates, the creditworthiness of issuers, and the availability of liquidity in the market. 

Medium Duration Funds vs Short Duration Funds

When investing in debt funds, choosing one out of Medium and Short Duration Funds cannot be very clear. While both types of funds invest in debt and money market instruments, their investment horizon, risk level, and potential returns differ.

Who should invest in Medium Duration Funds?

If you:

• Plan to invest for 3 to 4 years
• Are okay with moderate risk for better returns
• Want better returns than bank deposits
• Seek both regular income and potential capital appreciation

Then medium-duration funds are the right investment for you.

Factors to consider before investing in Medium Duration Funds in India

Before you decide to invest in Medium Duration Funds, it's essential to consider several factors that can influence your investment decision:

Risks

Like all debt funds, medium-duration funds are also subject to various risks, including interest rate, credit risk, and liquidity risk.

• Interest rate risk refers to the potential for investment losses due to changes in interest rates. 
• Credit risk is the possibility that the issuer of a debt instrument, like the government or the corporate, may default on their obligations. 
• Liquidity risk is the risk that you may not be able to sell your investment quickly at a fair price. 

Returns

The returns from Medium Duration Funds come from the interest income from the debt instruments they hold and the capital appreciation due to changes in interest rates. While these funds aim to provide stable returns, they are not guaranteed.

The returns can be volatile due to changes in interest rates and the credit quality of the instruments. Top funds in this category over 3 years have given their investors around 7-9% returns per annum.

Expense Ratio

The expense ratio measures the cost of managing the fund. It includes the fund management fee, administrative expenses, and other operational costs. 

A higher expense ratio can eat into your returns, so choosing funds with a lower expense ratio is advisable. While most funds have an expense ratio of around 0.3 to 1%, it's still a great idea to consider the expense ratio before investing money into them.

Investment Plan

You can invest in Medium Duration Funds through a Systematic Investment Plan (SIP) or a lump sum investment. A SIP allows you to invest a fixed amount regularly, while a lump sum investment involves investing a large amount at once.

Yield to Maturity (YTM)

YTM is the total return anticipated on a bond if held until its suggested investment period and is expressed as an annual percentage rate. In the context of Medium Duration Funds, a higher YTM could indicate higher expected returns, but it could also imply higher risk.

Fund's Portfolio 

It's essential to look at the fund's portfolio before investing so check the credit quality of the instruments the fund is investing in. Funds that invest in high-quality tools (rated AAA, AA, or A) are less risky than those that invest in lower-rated instruments (rated CCC, CC or lower).

Taxation of Medium Duration Funds

The taxation of Medium Duration Funds is similar to that of other debt mutual funds. The gains are taxed according to your income tax slab when you sell your investment. 

Conclusion

If you're thinking about investing your money for a while and you're okay with taking a moderate amount of risk, Medium Duration Funds could be an excellent option for you to consider. These funds have the potential to give you better returns than short-term investments, but it's essential to keep in mind that there are some risks involved as well. 

Before making any decisions, it's essential to closely examine your investment goals, your comfort level with risk, and your overall financial situation. That way, you can make the best possible choices for your future.

Medium Duration Funds: Frequently Asked Questions (FAQs)

What are the debt instruments that Medium Duration Funds invest in?

Medium Duration Funds can invest in various debt instruments, including money market instruments, government bonds or securities, commercial papers, and corporate bonds.

What is the duration of Medium Duration Funds?

The duration of Medium Duration Funds is between 3 to 4 years.

Is there any exit load on Medium Duration Funds? 

The exit load on Medium Duration Funds varies from fund to fund. Many funds may not levy an exit load on the redemption of units, primarily if they are held for more than a year.

What is the average return expectation under Medium Duration Funds? 

The average return expectation under Medium Duration Funds within a year of investment is around 8% depending on the fund's performance. However, it's important to remember that returns in mutual funds are not guaranteed and can vary based on market conditions.

Can I invest in Medium Duration Funds through SIP? 

You can invest in Medium Duration Funds through a Systematic Investment Plan (SIP). A SIP allows you to invest a fixed amount regularly, making it a disciplined and systematic investment approach.

Are Medium Duration Funds safe? 

While Medium Duration Funds are generally considered less risky than equity funds, they are not entirely risk-free. They are subject to interest rate, credit, and liquidity risks. Therefore, assessing your risk tolerance before investing in these funds is essential.

What is the tax treatment for Medium Duration Funds? 

Medium Duration Funds are taxed like debt funds. The gains are taxed according to your income tax slab if you sell your investments.