Investors who aim to save their capital and get steady returns often pick debt funds over others. Low-duration mutual funds are a wise choice for those with a quick timeline in mind and want to keep risks moderate. Is choosing a low-duration mutual fund the proper decision for you? Let’s look at each piece separately.
What is a Low-Duration Mutual Fund?
An example of a low-duration debt mutual fund is one that bets mainly on fixed-income assets which include government bonds, corporate bonds, treasury bills and commercial papers. These investments usually remain active for a time frame of 6 to 12 months. In summary, the fund manager aims to have the portfolio structured so that the average period it takes to get the cash flows from the investments is kept short. It makes the company less affected by changes in interest rates.
How Do Low-Duration Funds Work?
Since low-duration funds target short-term or moderate-term returns, they purchase debt securities that have shorter to moderate maturity. With the aim to minimize interest and reinvestment risks, these funds try to offer more earnings than those in overnight or liquid accounts. These funds experience less volatility and changes from fluctuations in interest rates than long-duration funds do. When interest rates increase, long-term bonds tend to lose a lot of their value. Still, funds that keep the money for a short period are usually protected from such changes.
Who Should Consider Low-Duration Funds?
1. You Have a Short Investment Horizon: If you’re looking to park your money for 6 to 12 months — for instance, saving for a short-term goal like paying tuition fees, planning a vacation, or creating an emergency corpus — these funds are ideal.
2. You Want Better Returns Than a Savings Account: Low-duration funds generally offer better returns than traditional savings accounts or fixed deposits of similar tenure, although they do carry some market-related risk.
3. You Have Moderate Risk Appetite: While they are relatively safer than long-duration debt funds or equity funds, they are not entirely risk-free. They carry credit risk (if the issuer defaults) and interest rate risk, albeit at a lower level.
4. You Want to Diversify Your Portfolio: If your investment portfolio is heavily skewed towards equities, adding low-duration funds can provide stability and reduce overall portfolio volatility.
Also read: Do You Own These Top Defence Mutual Funds in 2025? Check Your Portfolio Now!
Benefits of Low-Duration Mutual Funds
1. Low Interest Rate Sensitivity: The shorter duration makes these funds less vulnerable to rising interest rates, which often negatively affect long-term debt funds.
2. Liquidity: Most low-duration funds offer good liquidity. You can redeem your investment quickly, usually within 1–2 business days, though exit loads may apply if withdrawn early.
3. Reasonable Returns: While not as high-yielding as equities, these funds tend to deliver higher returns than savings accounts and many short-term deposits, especially in a stable interest rate environment.
4. Tax Efficiency (if held over 3 years): If you hold these funds for more than 36 months, you may benefit from long-term capital gains tax with indexation, which can be more tax-efficient than interest on fixed deposits.
Risks Involved
- Credit Risk: If the fund invests in lower-rated instruments for higher yields, there’s a chance of default by the issuer.
- Interest Rate Risk: Although minimal, there’s still some risk if interest rates move sharply in either direction.
- Liquidity Risk: During periods of economic stress, liquidating the fund’s underlying assets might become challenging.
- To mitigate these risks, choose funds with a high-quality portfolio (AAA-rated instruments, sovereign debt) and a trusted fund house with a solid track record.
How to Choose the Right Low-Duration Fund
- Portfolio Quality: Check the credit ratings of the instruments the fund holds.
- Expense Ratio: Lower expense ratios help you retain more of your returns.
- Fund Manager Track Record: A skilled manager can make prudent decisions to minimize risk.
- Historical Returns: Look at past performance, but don’t rely on it entirely.
Conclusion
You can benefit from including low-duration mutual funds in your portfolio , especially if you aim for safety and a better return in a moderate time frame than savings accounts give. Yet, you should first look at your financial goals, how much risk you can handle and how long you plan to invest. If you need a secure place for your investment that won’t last long, a low-duration mutual fund is a good match. It is important to talk to a financial advisor before making any investing choices.
Written by Promita Ghosal
