Can Long Duration Funds be next favorite of debt mutual fund investors? Should you invest?

The Reserve Bank of India (RBI) kept the repo rate unchanged at 6.5% for the seventh consecutive time. However, CRISIL, in one of its research reports, stated that it expects the RBI to initiate rate cuts in mid-2024.

If there is one debt mutual fund that benefits from interest rate cuts, it would be long-duration funds. If the market sentiment is riding this expectation, then this year, many AMCs are betting on the same trend.

Take, for instance, Kotak’s long-duration fund and Bandhan’s long-duration fund, was launched by Kotak’s mutual fund and Bandhan’s mutual fund this year.

But before you follow market experts’ commentary, you must approach this fund cautiously. Interest rates can move in any direction, and predicting the RBI’s rate-cut actions is difficult.

What are long-duration funds:

As per Sebi categorisation, under long-duration funds, investments are made in debt & Money Market Instruments with a portfolio duration greater than 7 years.

Bond prices and interest rates are inversely related. When interest rates go up, bond prices fall, and vice versa. The impact of bond prices is reflected in the Net Asset Value (NAV) of mutual funds.

As per the market experts, investing in short-duration debt mutual funds is less risky if interest rates are expected to go up. However, if the Interest rates are reduced aggressively this year, it can help longer-duration debt funds post double-digit returns.

“Categories such as Long Duration Fund, which houses funds that tend to maintain higher maturity profile, found favor among investors. The flow trend in these segments suggests that investors have pre-emptively started to show interest in funds from these categories, largely driven by expectation of interest rate cut in the later part this year,” explained Himanshu Srivastava, Associate Director – Manager Research, Morningstar Investment Research India Private Limited.

Taxation:

Long-duration funds are taxed as debt mutual funds. As of April 1, 2023, debt fund investments will no longer be eligible for the long-term capital gains (LTCG) indexation benefit.

Instead, the investor’s gains will be taxed as part of their taxable income. No matter how long debt fund units were held, all profits on newly purchased units after April 1, 2023, will be considered short-term capital gains (STCG).

Returns:

Funds such as the SBI Long Duration Fund and UTI Long Duration Fund have given a return of 8.02% and 7.93% in the last one year as of April 16, 2024. Nippon India Nivesh Lakshya Fund has given a return of 7.86%,4.94%, and 7.73% over 1,3 and 5 years, respectively, over the same period.

Should you invest?

This scheme is suitable for investors seeking long-term wealth creation for their long-term goals with a time horizon of 3-5 years. However, Investors should be aware of risks before investing in these funds.

Only those investors who have a high tolerance for interest rate risk should invest in these funds. Investors should also constantly be aware of the interest rate cycle. An increased interest rate can drastically impact returns if not reviewed periodically.

Conclusion:

Before investing, investors should consider their investment objectives and risk appetite. For more risk and financial goal clarity, it is recommended that they seek the help of a financial advisor.