Medium term debt funds are debt instruments which come with an average maturity of greater than 3 years or more. Debt mutual funds are classified by maturity date, as maturity date is one of the important elements in calculating returns. In a positive returns environment, medium term debt bonds pay a higher return for a particular credit quality as compared to a short term debt mutual fund.
These funds invest cardinally in debt instruments with a maturity within 3 to 7 years as compare to any other regular income fund. The maturity of these funds is greater than liquid or short term funds but comparatively less than a long term fund.
The risk return trade off.
Contrary to the popular belief, debt funds are not completely risk free. The standard risks of investing in the debt asset class apply to medium term debt funds as well. This typically includes interest rate, credit and liquidity risk. The former one is decided on a macro level while the latter two are more micro and fund specific. The asset class is comparatively safer but some part of the holdings do run a sizeable risk if one of the companies in the portfolio comes crashing.
To mitigate the risks, the fund manager looks at diversification into government securities and corporate bonds. Government securities are free from any credit risk but the long duration bonds may be exposed to liquidity risk at some level. Keeping in line with the inverse relationship between risk and return, the Gilts yield less than any AAA rated or lower rated bond. Corporate bonds, on the other hand, are more skewed towards relatively high-risk high-return side of the scale. The fund manager seeks to maintain a stable balance to achieve the fund objectives.
Who is it for?
There is no standard rulebook which can answer this question. It is highly dependent on the following factors: Risk taking capacity, the time horizon for investment, liquidity requirement, medium and long term financial goals and overall portfolio of the investor.
Are medium term debt mutual funds a better pick over FD’s.
Historically, fact and figures prove that debt mutual funds have given better post-tax returns as compared to FD’s. There are debt instruments like FMPs which are now considered as the substitutes for bank deposits. Some FMPs are medium term debt mutual funds which come with a fixed maturity period. FMPs usually invest in debt instruments like certificate of deposits, money market instrument, corporate bonds and commercial papers.
On the other hand, FD’s are one of the only financial instruments wherein there is a fixed maturity for a fixed period but are liquid in nature and gives you an option to exit whenever you wish to.
The Bottom Line
All investment in the financial markets is subject to investors risk taking ability, the financial goal and the tenure for which the funds are to be invested. Medium term funds are considered a viable option for investors who are conservative in nature but are ready to take a medium risk for higher returns.