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Long-term investing isn’t always limited to equity mutual funds. Even debt funds offer long-term investing opportunities through long term debt funds. Long term debt invest in debt & money market instruments with a long maturity . The funds aim to capture the benefits of interest rate changes (falling rates specifically) over the long-term horizon.
In this article, we discuss what long-term mutual funds are, highlighting their key features and benefits. We also explore how the returns from these funds are impacted by market cycles and interest rate changes.
Table of Content
Understanding Long term debt funds
A long-term debt fund is an open-ended debt mutual fund scheme that invests primarily in debt & money market instruments that have long maturities. According to Categorization & Rationalization of Mutual Fund Schemes, long-term debt funds invest in debt and money market instruments such that the Macaulay duration of the portfolio is greater than 7 years.
This means a long-term debt mutual fund scheme typically invests in instruments such as:
Long-term government securities
Corporate bonds with long maturity
Non-convertible debentures
And other long term debt securities
Long term debt fund portfolio consists of instruments having fixed coupon payments. They also aim to benefit from capital appreciation over the long-term, which may happen if rates fall and bond prices rise.
Features of Long-Term Debt Mutual Funds
Now that you know the meaning of long-term debt mutual funds, let's understand their key features:
1. Long-Term Maturity Profile
As mentioned earlier, long-term mutual funds invest in debt & money market instruments like G-Secs and corporate bonds that have a long maturity.
2. Greater Sensitivity to Interest Rate Changes
Since long-term funds have a longer maturity profile, they may be more sensitive to changes in interest rates compared to short-term debt funds. So, when interest rates decline, long-duration bonds may rise in value. Alternatively, when interest rates increase, bond prices may fall.
3. Suitable for Long-Term Investors
Investors with a long-term investment horizon of over 7 years may consider these funds for their long-term goals, like retirement planning.
4. Income Generation
Long term debt funds invest in bonds that typically pay regular interest. This interest income, along with potential price changes in the underlying bonds, may contribute to the fund performance over time.
Advantages of Investing in Long-Term Funds
Here’s a list of the key benefits of long-term mutual funds:
1. Potential to Benefit from Falling Interest Rates
When interest rates fall, the price of long-duration bonds typically rises. Since long-term mutual funds hold such securities, they may also benefit from such favourable interest rate movements.
2. Portfolio Diversification
Long term debt funds can add a layer of diversification to an investor’s equity-heavy portfolio. Since debt instruments tend to behave differently from equities under various market conditions, they may help spread overall portfolio risks and may help in managing market volatility.
3. Easy to Access
Investors can invest in long term debt funds via SIPs for as little as Rs. 500. They can choose from a range of long-term mutual fund schemes offered by different AMCs to start a long-term SIP investment with a nominal amount.
4. Professional Management
All long term debt funds are managed by skilled and experienced fund managers. They use market analysis, interest rate tracking, and credit risk assessment strategies to manage these funds with the objective to perform better over long term.
However, there is no guarantee or assurance that the investment objective will be achieved. This category of scheme doesn’t assure or guarantee any returns.
Understanding Long-Duration Fund and Market Cycles
When considering returns from long-term funds, investors should remember that, like all debt instruments, market cycles and interest rate changes play a key role here too.
But the extent of impact is generally greater when it comes to long-duration funds. The logic is simple: Since interest rates are more likely to experience fluctuations over the long-term, these funds may face higher interest rate risks (especially if rates are slowing rising).
Here’s how interest rate cycles tend to impact the performance of long-term funds:
When interest rates rise: When interest rates start rising, older bonds become less attractive, and their prices fall. So, the price of the long-duration fund’s underlying bonds may also fall and lead to a lower NAV.
When interest rates fall: When interest rates start falling, bond prices start rising. In such phases, long-duration funds could potentially benefit from both interest income and capital appreciation in the underlying bonds.
So, starting long-term SIP plans or investing in long-term funds with lump-sum contributions may be beneficial in falling or low-interest-rate settings.
Long-Term Mutual Funds Suitability for Investors
Here are some investors who may find long-duration funds suitable for investing:
Those with a Moderate to High Risk Appetite
As debt funds, long-duration funds are less risky than equity-oriented schemes. But this doesn’t make them risk-free. In fact, they are riskier (in terms of interest rate risk) than debt funds that have shorter horizons. So, these funds may be suitable for investors that have a high risk tolerance level.
Those with a Long-Term Horizon
Investors who are looking for long-term capital appreciation or who are investing for goals over 7 years away may consider long-duration funds.
Those Looking for Portfolio Diversification
Investors who are looking to diversify their portfolios beyond equity investments may consider long-term funds as well.
Those Who Expect the Interest Rates to Fall/Remain Low
Investors who anticipate the overall market interest rates to fall in the future or remain low may consider long-duration funds. There may be a possibility of better capital appreciation as bond prices rise with low/falling interest rates.
What to Consider Before Making a Long term debt fund Investment?
Before you begin shortlisting long-term mutual funds to invest in, consider these things:
Interest Rate Outlook
The performance of long-term mutual funds depends on interest rate cycles, as explained above. That’s why it’s important to keep an eye on the RBI’s monetary policy guidance, and interest rate outlook before making the investment.
Your Investment Horizon
As mentioned earlier, these funds are generally better suited for investors with a longer horizon who can remain invested through interest rate cycles. So, they may be worth considering only if your goals are more than 7 years away.
Your Risk Tolerance
Although long term debt funds are debt funds and carry lower market risk, they still have a high interest rate risk. What this means is that long-duration funds may be riskier than other debt fund categories that have shorter maturities. So, they may be suitable only if you’re ready to tackle interest rate fluctuations over the long-run.
Tax Considerations
Like all debt funds, long-term mutual fund taxes depend on your applicable tax slab, regardless of the holding period. So, if you belong to a higher tax bracket (30%), you may have to pay higher capital gains tax on returns. This may be much higher than the LTCG applicable on equity fund schemes (12.5% after Rs. 1.25 lakh/year exemption).
Conclusion
Long-duration funds invest in debt instruments that have a long maturity. This long duration also plays a role in how they perform and their overall suitability:
These funds may perform better when interest rates decline and bond prices rise.
They can experience temporary declines when interest rates increase.
They are generally better suited for investors with a longer investment horizon.
For this reason, long term debt funds are typically considered by investors who are comfortable staying invested through interest rate cycles and using them as part of a well-diversified long-term portfolio.
Disclaimer
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