Medium duration funds are a category of debt mutual funds that primarily invest in fixed-income instruments with an average portfolio maturity of 3 to 4 years. These funds aim to provide higher returns than short-term debt funds while maintaining moderate risk exposure. They typically invest in corporate bonds, government securities, money market instruments, and other debt securities.
Medium duration funds can be ideal for investors seeking steady income with relatively lower interest rate risk compared to long-term debt funds.
Key Takeaways
- Medium duration funds provide a balance of moderate risk and higher returns than low duration funds.
- They are suitable for investment horizons of 2–5 years.
- Taxation benefits are available if held for more than 3 years with indexation.
- Professional management ensures diversification and risk mitigation.
How Medium Duration Funds Work?
Medium duration funds pool money from investors to create a diversified portfolio of debt securities with maturities around 3–4 years. The fund manager actively selects securities based on credit quality, yield, and duration, aiming to optimise returns while managing interest rate risk. Returns are generated through interest income from bonds and capital gains from changes in the market value of these securities.
Investors can participate via lump-sum investments or Systematic Investment Plans (SIPs). The Net Asset Value (NAV) of the fund fluctuates daily based on market interest rates and credit spreads, but medium duration funds generally exhibit lower volatility compared to long-duration funds due to shorter maturity.
Benefits of Medium Duration Funds
- Higher returns than low duration and liquid funds, making them suitable for medium-term goals.
- Moderate interest rate risk compared to long-term debt funds.
- Diversification across various debt instruments reduces credit risk.
- Professional management ensures selection of high-quality bonds and optimal portfolio allocation.
- Liquidity allows redemption typically within 1–3 business days.
Factors to Consider Before Investing
- Investment Horizon: Suitable for investors with 2–5 year goals.
- Interest Rate Movements: NAV can fluctuate if interest rates rise sharply.
- Credit Risk: Focus on funds with high-quality bonds to reduce default risk.
- Expense Ratio: Check fund charges; higher costs can reduce net returns.
- Tax Efficiency: Consider potential capital gains taxes when planning investment.
Taxation
Short-term capital gains (STCG) are applicable if the fund is redeemed within 3 years and taxed as per the investor’s income slab.
Long-term capital gains (LTCG) apply for holdings beyond 3 years and are taxed at 20% with indexation benefits, making medium duration funds tax-efficient for medium-term investors. Dividends, if any, are taxed in the hands of the investor according to their income slab.
Conclusion
Medium duration funds can be a choice for investors seeking better returns than short-term debt instruments while maintaining moderate risk exposure. Investors should consider factors like interest rate movements, credit quality, and taxation before investing to optimise returns and meet their investment objectives.