Due to the increasing volatility in the market, investors are actively looking to create resilient and balanced portfolios that have the potential to weather multiple economic upheavals. In this endeavour, investors who wish to invest for short-term monetary requirements, can consider Low Duration Funds.
As the name suggests, Low Duration Funds invest in debt instruments with a duration between six to twelve months. In a rising interest rate environment, the mark to market losses on bonds is relatively less. Not only does this help in protecting investors’ returns, but also make Low Duration Funds a viable parking solution for investors and a good entry point for them to build their debt portfolio.
To help investors understand the various tenets of this category and the various nuances of building wealth in the short-term, YourStory spoke to Devang Shah, Co-head, Fixed Income, Axis Mutual Fund.
Here are the key takeaways from the conversation.
How does a Low Duration Fund work?
Low Duration Funds, as the name suggests, typically invest in short-term financial assets with a duration between 6‐12 months; meaning that they have a relatively low-interest rate risk.
“When interest rates rise, the mark to market loss on these bonds is relatively less,” said Devang. When interest rates increase, the funds cut back on duration to minimise capital losses, while simultaneously earning higher interest rates on new bonds.
Axis Mutual Fund’s bouquet of Low Duration Products
Devang also spoke about three Low Duration Funds by Axis Mutual Fund. These include: Axis Ultra Short Term Fund – an open-ended ultra-short term debt scheme investing in instruments such that the Macaulay duration of the portfolio is between three months and six months; A moderate interest rate risk and moderate credit risk, Axis Money Market Fund – an open-ended debt scheme investing in money market instruments; a relatively low interest rate risk and moderate credit risk, and finally, Axis Treasury Advantage Fund – an open-ended low duration debt scheme investing in instruments such that the Macaulay duration of the portfolio is between six to twelve months; a relatively high interest rate risk and moderate credit risk
“Typically, the decision of whether to invest in Low Duration Funds depends largely on the investor’s investment horizon. If the investment horizon is less than three months, they are advised to consider liquid to overnight category of funds. If the investment horizon is more than three months but less than twelve months, investors are advised to consider Low Duration Funds in the Ultra Short Term or Money Market categories,” said Devang.
Factors to consider before investing in Low Duration Funds
Typically, investors consider Low Duration Funds as parking solutions. An important question to understand, therefore, is when is the right time to make the shift from liquid to low duration funds. “A key factor that an investor should look into, while investing into the low duration category, is the gap in Yield to Maturity (YTM) between liquid and other low duration categories,” said Devang, while adding that understanding yield gaps are also important to study from a risk-reward perspective.
“Another important parameter to consider is the banking system liquidity. When the interest rate cycle is on the rise, one can park their money into low duration categories. Once the rate hikes are behind us, investors should typically shift their money from these low duration categories and manoeuvre them towards short- to medium-term funds where the investment horizon is two to three years,” he advised.
Negotiating the market volatility
“If one were to look at the underlying securities in low duration funds, most of them are maturing in the six to twelve-month period, making them relatively less sensitive to rising interest rates. Currently, we are witnessing steep rate increases which makes lower duration funds a good entry point for investor looking for some solution against volatility. Typically, duration acts like a hedge in a rising rate environment. Our understanding is that, the current market environment is good for short- to medium-term funds,” said Devang, explaining the relevance of these funds for investors looking to deal with market volatility.
“For investors who are just looking at parking solutions, Ultra short-term low duration funds make a lot of sense,” he said.
“However, for investors who are looking at medium-term solutions, with an investment horizon of between one and three years, short-term, medium-term funds, and target maturity funds, typically make a lot of sense at this point of time” he added.
Source: Axis MF Research
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