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Short duration or long duration debt funds : Where should you invest?

Long duration debt funds on a average have given 12% returns in the last one year, Medium to long duration schemes have given close to 10% returns and short duration debt funds have generated 8.80% returns in the last one year.Premium
Long duration debt funds on a average have given 12% returns in the last one year, Medium to long duration schemes have given close to 10% returns and short duration debt funds have generated 8.80% returns in the last one year.

The Reserve Bank of India has cut the benchmark repo rate by 115 basis points since the Covid crisis began, bringing it down to record lows of 4%.

Investors do not invest in debt mutual funds with an expectation of double digit returns. Debt is usually added to the investment portfolio to balance the high risk in equities in the portfolio. Thus, most of the times, it is advised to stay in the shorter end of the yield curve, where the volatility is lesser. But the high returns in the medium and longer end of the yield curve has put investors in frenzy. Long duration debt funds on a average have given 12% returns in the last one year, Medium to long duration schemes have given close to 10% returns and short duration debt funds have generated 8.80% returns in the last one year.

Given the attractive returns across debt funds and the risk involved, is it wise to invest in long duration funds now? What is the risk involved? Read on to know where to invest the debt portion of your portfolio and why.

Mutual fund managers believe the sharp reduction in interest rates has cheered the long duration funds. They believe investors who have around five years of horizon and can bear the volatility during that term, can go for long duration funds to enjoy higher returns.

"There has been a structural downtrend in interest rates over the last 15-20 years. This has helped long duration funds perform well. As long as the investors have an investment horizon of at least 4-5 years, and they are comfortable with interim price and NAV volatility, long duration funds should be part of the core debt allocation in any investor’s portfolios," says Vivek Sharma, Fund Manager – Fixed Income Investments, Nippon India Mutual Fund.

The Reserve Bank of India has cut the benchmark repo rate by 115 basis points since the Covid crisis began, bringing it down to record lows of 4%. Mutual fund managers expect lower returns from the shorter duration funds going forward. They say, investors need to be sensitised towards moderate return expectations from these products going forward.

"The amount of excess liquidity in the banking system has ensured that shorter end bonds and money market securities have witnessed a substantial easing in yields as well as spread tightening. Given this context, even as the monetary policy cycle is expected to remain easy with policy rates staying low for a bit longer, return expectations from all shorter duration debt products need to recalibrated downwards," says Rajeev Radhakrishnan - Head of Fixed Income, SBI Mutual Fund.

However the short term fund are expected to outperform the bank fixed deposits on a pre or post tax basis.

Mutual fund advisors ask investors to choose a debt fund basis their investment horizon.

"The easiest and time tested strategy is to marry your fund category selection with your investment horizon, this cancels out interim volatility. More important, this pre-empts impulsive over-allocation or under allocation basis near term market movements," says Vivek Sharma.

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