Debt funds classified as low-duration funds invest in short-term debt instruments, with the fund portfolio having a duration of six to twelve months. Low-duration funds have a considerably higher interest rate risk and credit risk since they contain assets with a longer maturity and lower credit quality than overnight or liquid funds. In this blog, we’ll discuss the reasons to have these debt funds in your portfolio.
Top 5 Reasons for Having Low-Duration Funds in Your Portfolio
Let’s look into the benefits of investing in low-duration mutual funds:
Moderate Risk
Since low-duration funds typically do not hold securities with maturities longer than 1- 1.5 years, they have a minor amount of interest rate risk. They benefit from this when interest rates drop, the loss of interest revenue on newly issued bonds is far less than the capital gains on the value of already-issued bonds. The funds shorten the duration to reduce capital losses when interest rates rise, but they also earn greater interest rates on new bonds at the same time.
As a result, compared to funds with longer durations, the value of those with shorter durations is less volatile. However, most of these long-duration funds hold good-quality debt, so the fund category remains appropriate for investors who can tolerate a reasonable amount of risk.
Competitive Returns
Since low-duration funds can assume more credit and duration risk, they often perform better than liquid funds. Since these funds can earn more capital gains by owning bonds with longer maturities than ultra-short-duration funds, they may also outperform the latter.
In addition to their ability to assume more credit and duration risk, low-duration funds tend to benefit from higher returns due to their strategic investment in bonds with longer maturities.
Short to Intermediate Maturities
The majority of investments made by low-duration mutual funds are made in fixed-income instruments with maturities that are short to intermediate, usually between one and three years.
By concentrating on shorter-term bonds, interest rate risk is mitigated, and the funds are less susceptible to fluctuations in interest rates than longer-duration bond funds. Concentrating on shorter-term bonds allows low-duration mutual funds to mitigate interest rate risk, as these bonds are less sensitive to fluctuations in interest rates than their longer-duration counterparts.
Stability
Low-duration funds typically exhibit lower volatility compared to longer-duration bond funds, providing stability to your portfolio, especially during periods of market turbulence or rising interest rates.
The lower volatility of low-duration funds not only provides stability during market turbulence but also offers a cushion against the impact of rising interest rates. This resilience can help investors navigate uncertain market conditions while preserving capital and achieving their long-term financial goals.
Diversification
Including low-duration mutual funds in your portfolio can enhance diversification, as they offer exposure to a different segment of the fixed-income market compared to traditional short-term or equity investments, thus reducing overall portfolio risk.
It increases diversification by providing exposure to a different segment of the fixed-income market compared to traditional short-term or equity investments. As a result, they reduce overall portfolio risk and enhance long-term stability.
Final Words
Including low-duration mutual funds in your investment strategy offers a prudent approach to balancing risk and return in your portfolio. With their potential for stable returns and reduced volatility, these funds can fortify your financial position.
Happy Investing!
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