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Low Duration Mutual Funds

Average Return 5.54%
No of Funds 18

How do Low Duration Mutual Funds Work?
Who Should Invest in Low Duration Funds?
Taxation on Low Duration Funds
How to invest in Low Duration Funds?
Frequently Asked Questions

How do Low Duration Mutual Funds Work?

To understand how low-duration funds work, it is necessary first to understand the concept of duration. That is because the duration of a fund affects its investment decisions as well as the type and amount of returns earned by it.

What is Duration? The duration of a debt fund measures how much the fund's value fluctuates in response to changes in market interest rates. Duration is also known as interest rate risk. Therefore, the higher the duration, the more volatile the fund value, and the greater its interest rate risk. Calculating duration is quite tedious and requires a complex formula and detailed data on the fund's investments. For most investors, a good thumb rule is to estimate duration based on the maturity of bonds held by the fund. Funds holding long-maturity bonds have higher durations as compared to funds that hold shorter maturity bonds if a fund increases its holdings of long-term bonds, the duration of the fund increases, as does its interest rate risk.
Defining Low Duration According to SEBI rules, low-duration funds have to maintain fund duration between 6-12 months. This means that low-duration funds are likely to invest in short-term debt securities only. Thus, low-duration funds have relatively low interest rate risk.
Where do low duration funds invest? There are no restrictions on the type or credit quality of debt assets to be held by low-duration funds. Hence these funds invest in a wide range of securities, including money market securities, government securities, corporate bonds, securitized debt, hybrid instruments like REITs, permitted derivatives, or other mutual fund units.
Sources of Earning Low duration funds earn through interest as well as capital gains from their debt securities. These funds boost interest earnings by holding a part of their assets in bonds with credit ratings of AA or lower, which pay relatively higher interest rates. Remember, lower-rated bonds yield more but also increase the risk of default.

Most low duration funds will take on some credit risk to deliver higher returns. Low duration funds also have the potential to generate capital gains. When interest rates are falling, fund managers will increase exposure to longer maturity bonds in order to push up the value of the fund. The loss of interest income from investing fresh inflows at lower interest rates will be more than made up by the gain in the capital value of existing bonds. Thus, low duration funds use strategies based on credit risk as well as interest rate risk to generate returns.

Who Should Invest in Low Duration Funds?

Investors with more than at least a 3-month investment horizon: Low duration funds are ideal for those with an investment horizon of 3 months or higher. Investors with very short investment horizons are better off investing in low-risk overnight or liquid funds. However, for holding periods longer than 3 months, low duration funds offer higher returns in exchange for a small increase in risk. Investors can use them for temporary parking of surpluses from the sale of a property, annual bonus, etc., or for accumulating funds towards a short-term financial goal.
Investors who want regular income: Low duration funds provide regular income through a combination of interest earnings and capital gains. Investors with a moderate risk appetite can allocate a part of their portfolio to these funds and use an SWP to create a stream of income flows.
Investors who want an alternative to bank deposits: Investors with a moderate risk appetite may find low duration funds more attractive than bank deposits as they offer better liquidity as well as have the potential to earn higher market?linked returns.
Medium to Route investments in Equity Funds: Low Duration funds can be used to hold funds while using an STP to route investments systematically into an equity fund or hybrid fund. While it is more common to use liquid funds as the holding vehicle, investors with a slightly higher risk tolerance can benefit from the higher return potential of low duration funds.

Taxation on Low Duration Funds

Investors earn dividend income and capital gains from low duration funds. Dividend income is not taxable for investors. However, capital gain, which is the difference between the purchase price and selling price of the units, is taxable. The rate of tax on capital gains depends on how long the investor has held the units of the low duration fund.

Short-Term Capital Gains Tax: If an investor holds the units of the fund for up to 3 years, capital gains are considered as Short-Term capital gains and taxed at the income tax slab rate applicable to the investor.
Long-Term Capital Gains Tax: If an investor sells the units of a low duration fund after holding it for more than 3 years, it is classified as a long-term capital gain. In this case, the investor is allowed the benefit of indexation, which means that before calculating the capital gain, the purchase price can be increased to adjust for inflation (using an index provided by the Government). In other words, the taxable amount is reduced due to indexation. Long-term capital gains are currently taxed at a lower rate of 20%.

How to invest in Low Duration Funds?

It is quite easy to invest in Low Duration mutual funds on ET Money. Here are the steps that you have to follow.

Register online on ET Money app or website
Head to Mutual Funds sections and choose the Low Duration fund you want to invest in.
Click on invest and choose the amount and mode of investment (SIP or Lumpsum)
Provide your KYC details (Pan number, Bank details) and complete your investment.

Frequently asked Questions

Which are the best Low Duration Mutual Funds to invest in 2022?

These are top 5 Low Duration funds you can invest in 2022

Fund Name	Fund Category	ETM Rank	5 Year Return (Annualized)
Aditya Birla Sun Life Low Duration Fund	Debt	# 3 of 21	6.98 % p.a.
Kotak Low Duration Fund	Debt	# 8 of 21	6.98 % p.a.
HDFC Low Duration Fund	Debt	# 9 of 21	6.68 % p.a.
ICICI Prudential Savings Fund	Debt	# 13 of 21	6.63 % p.a.
Nippon India Low Duration Fund	Debt	# 3 of 21	6.5 % p.a.

How long should I stay invested in Low Duration Mutual Funds?

Low Duration Debt Mutual Funds are ideal for an investment horizon of at least 1 year.

Where do Low Duration Mutual Funds invest?

Low Duration Funds lend for 6 to 12 months. They mostly lend to good quality borrowers like highly-rated companies and the government.

Are Low Duration Mutual Funds high risk?

Low Duration Fund's relatively longer lending duration makes them somewhat susceptible to interest rate movements, and as a result, they can be relatively more volatile. However, they are still a low-risk investment avenue.

What kind of returns can i earn from Low Duration ?

Low Duration Funds have on an average delivered 4.09% p.a. returns in the last 1 year. Their 3 and 5 year annualized returns are 5.54% and 5.75%. p.a.