Low Duration Mutual Funds: All You Need to Know in Detail

Low duration mutual funds are a type of fixed-income investment popular among investors who prioritise capital preservation and regular income generation. These are debt funds that primarily invest in debt securities with shorter maturities and tend to have relatively low risk and stable returns. The duration of the fund portfolio is around 6 to 12 months.

Let us understand in detail what are low duration mutual funds, their features, taxation and how do low duration mutual funds work.

What are Low Duration Mutual Funds?

The term “low duration” refers to the relatively short maturity periods of the securities in which these funds invest. Low duration funds invest primarily in debt securities and money market instruments with shorter maturities, such as government securities, Treasury bills, commercial paper, money market securities and short-term corporate bonds. The average maturity of the portfolio of a low duration mutual fund typically ranges between six months to twelve months.

Low-duration mutual funds are a type of debt mutual fund that aim to provide higher returns than traditional savings accounts while keeping the risk at a moderate level. These funds are ideal for investors who want to invest in fixed-income instruments with a short to medium-term horizon of around one year.

How do Low Duration Mutual Funds Work?

Low Duration Mutual Funds offer a relatively low-risk investment option for investors seeking higher returns than savings accounts or money market funds. These funds invest in short-term debt instruments which are less sensitive to interest rate changes than securities with longer maturities.

The prices of securities with longer maturities typically are more volatile when there are changes in interest rates. However, by investing in debt securities with shorter maturities, low-duration mutual funds aim to reduce the impact of interest rate changes on their portfolio values.

Low duration mutual funds generate returns through interest income and the capital gains from the debt securities in their portfolios. Here’s a look at how do low duration mutual funds work:

Portfolio Composition: Low Duration Funds invest in debt securities with maturities of up to one year, such as commercial papers, corporate bonds, and treasury bills.

Risk and Return: Compared to other debt funds, low-duration funds have a lower level of risk. The returns, however, are typically greater than those provided by savings accounts or fixed deposits.

Active Management: The fund managers constantly monitor the credit quality of the underlying securities and adjust the portfolio to maintain a balance between risk and return.

Factors to consider while investing in Low Duration Mutual Funds

It is essential to weigh certain factors before investing in low duration mutual funds. These are:

Investment Horizon:

Investors who have an investment horizon of around one year can prefer low duration mutual funds.

Risk Tolerance:

Even though low-duration funds are considered low-risk investments, they are still subject to market volatility and fluctuations in interest rates. Hence, investors must evaluate their risk tolerance before investing in these funds.

Fund Performance:

Review the historical performance of the fund in different market conditions before investing in them. It is also essential to evaluate and compare its performance with its peers and benchmark.

Fund Manager Expertise:

Check the experience and track record of the fund manager in managing debt funds.

Portfolio Composition:

Analyse the underlying securities in the portfolio, including their credit ratings and sectoral exposure. Diversification is essential to minimise risk.

Expense Ratio:

Compare the expense ratio of different funds to select the one with the lowest fees.

Who Should Invest in Low-Duration Funds?

Low Duration Mutual Funds are ideal for investors with a low to moderate risk appetite and a one-year investment horizon. Check out who should invest in low-duration mutual funds.

Short-Term Investors:

Investors with a short-term investment horizon of 6 to 12 months can consider Low Duration Funds. These funds provide more optimised returns when compared to liquid funds while maintaining relatively low risk.

Individuals Seeking Regular Income:

Investors who are seeking regular income can invest in Low Duration Funds. The returns generated by these funds are in the form of interest income and capital gains from the debt securities.

Taxation for Low-Duration Mutual Funds

Low Duration Mutual Funds are a type of debt mutual fund. Investors holding these funds earn returns in the form of interest and capital gains. As per the latest amendments to the Finance Bill, 2023, capital gains on the debt mutual funds, that invest less than 35% in equity, are taxed at an individual’s personal income tax slab.