Mutual funds offer several options to investors looking to park money for the short term. Low duration fund (also known as savings fund) is one of them. The fund category often outperforms most other short-term investment options like liquid funds, overnight funds and ultra-short duration funds.
What is low duration fund?
Regulations mandate low duration funds to maintain fund duration between 6-12 months. As a result, these funds invest only in short term debt securities. However, they are free to choose the type and quality of securities. Therefore, you will find these funds investing in a variety of papers ranging from money market securities, government securities, corporate bonds, securitized debt, among others.
Who should invest in low duration funds?
Low duration funds are ideal for investors who have a horizon of at least 5-6 months and are comfortable taking slight risk.
"They (low duration funds) have higher flexibility when it comes to rating portfolio. If someone has an investment horizon of 6-9 months or 6 months to one year then low duration fund is better than liquid fund," said Mahendra Jajoo, CIO-Fixed Income, Mirae Asset Investment Managers (India).
Low duration funds can also be used as a medium to route investments in equity funds. Investors can hold a lumpsum amount in low duration fund and use the STP route to invest in equity funds systematically.
How are low duration funds taxed?
As investment in low duration fund is mostly for the short term (less than 3 years), the returns are taxed at the income tax slab rate of the investor. Investors holding low duration funds for over 3 years can avail the benefits of indexation to reduce tax outgo.
How to choose the right low duration fund?
When investing in a low duration fund, analyse the available options on two parameters — risk and expense ratio.
Low duration funds carry both interest rate risk and credit risk. While the interest rate risk is likely to be similar in case of all schemes due to regulations, the credit risk can vary. If you are averse to risks, look out for funds that invest only in top rated papers.
Now there is also a tool (potential risk matrix) to check the maximum risk a fund manager intends to take. Look out for a fund that falls in the safest cell of the matrix.
You should also look at the expense ratios associated with each scheme. Do not invest in a fund, which has unreasonably high charges.
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