3 Best Medium-to-Long Duration Funds for 2024

February 14, 2024 Mutual Fund

In the recently held February 2024 bi-monthly monetary policy, the six-member MPC, assessing the current and evolving macroeconomic situation, resolved to keep the policy repo rate for the sixth straight time in a row.

Further, contrary to the expectations, it was decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth.

These decisions were taken being cognizant of the risks to the inflation trajectory emanating from food prices, the possibility of adverse weather events, geopolitical events (mainly conflict in West Asia and the Red Sea), the impact on supply chains, and services and infrastructure firms higher input cost pressures and growth in selling prices.

[Read: Key Investment Risks to Watch Out for in 2024]

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That said, the CPI inflation projection for FY24 was kept unchanged at 5.4%. For the next fiscal year, FY25, assuming a normal monsoon, the CPI inflation has been projected at 4.5% (with Q1 at 5.0%; Q2 at 4.0%; Q3 at 4.6%; and Q4 at 4.7%), with the risks evenly balanced.

Graph 1: RBI’s Quarterly Projection of CPI Inflation (Y-o-Y)

(Source: RBI Monetary Policy Statement, 2023-24, February 6 to 8, 2024) 

The central bank also said the MPC will carefully monitor any signs of generalisation of food price pressures to non-food prices, which can fritter away the gains in the easing of core inflation.

Besides, it was observed that the cumulative effect of policy repo rate increases is still working its way through the economy.

So, where are Policy Interest Rates Headed?

Well, the path to interest rates is clearly hinged on the inflation trajectory. Meanwhile, headline inflation, after moderating to 4.9% in October, rose to 5.7% in December 2023 (owing to higher food prices, mainly that of vegetables). Core inflation – which excludes food and fuel – on the other hand, moderated to a 4-year low of 3.8% in December 2023 (enabled by the pass-through of monetary policy actions).

The RBI has observed that large and repetitive food price shocks are interrupting the pace of disinflation that is led by the moderation of core inflation. It views geopolitical events, their impact on supply chains, and the volatility in international financial markets and commodity prices as the key sources of upside risks to inflation.

The RBI has stated that the disinflation needs to be sustained, i.e. the monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. Thus, the MPC is resolute in its commitment to aligning inflation to the target. For this reason, it has decided to remain focused on the withdrawal of accommodation stance and has not passed on any indication of a rate cut soon.

So, the job is not yet finished, and according to the RBI, we need to be vigilant about new supply shocks that may undo the progress made thus far.

Table 1: RBI Monetary Policy Action Since the Summer of 2022

Data as of February 8, 2023
(Source: RBI Monetary Policy Statements) 

Since May 2022, the RBI has increased the policy repo rate by 250 basis points (bps) and withdrawn the stimulus measures of the COVID-19 pandemic. Amidst the lingering uncertainties, the RBI has decided to remain vigilant to ensure that we successfully navigate the last mile of disinflation.

The RBI has reaffirmed its commitment to bring down inflation to the target of 4.0% in a timely and sustainable manner.

I believe, given that much success is achieved in bringing down inflation with monetary policy actions and that headline inflation reading is, at present, within the upper band range set by the RBI, we are almost at the peak of the interest rate upcycle.

At the current juncture, it would be an opportune time to invest in medium-to-long duration debt mutual funds, wherein you benefit from higher yield and unlock capital growth.

What are Medium-to-Long Duration Debt Funds?

Medium-to-Long Duration Debt Funds, as characterised by the regulator, invest in debt and money market instruments such that the Macaulay Duration of the portfolio is between 4 to 7 years.

So, compared to Short Durations Funds (where the portfolio duration is 1 to 3 years) and Medium Duration Funds (where the portfolio duration is between 3 to 4 years), the maturity profile of a Medium-to-Long Duration Fund is high when it invests in various debt papers, including corporate bonds/debentures, government securities, and money market instruments.

Graph 2: Risk-Return Spectrum of Debt Funds

For illustrative purposes only
(Source: PersonalFN Research) 

On the risk-return spectrum, the Medium-to-Long Duration Debt Funds indicatively find their place two notches above the corporate bond funds. In other words, Medium-to-Long Duration Debt Funds are moderate-to-high-risk contenders.

In a rising interest scenario, the risk gets accentuated, and the return potential is limited. On the other hand, when the interest rates have plateaued and are expected to fall, that is when Medium-to-Long Duration Debt Funds benefit from higher yield and unlock the capital growth. This reflects the interest rate sensitivity of these funds, other than the fact that there is a slight credit risk.

Table 2: Performance of Medium-to-Long Duration Debt Funds

Data as of February 9, 2024
The list of funds cited here is not exhaustive.
Returns expressed are rolling returns in %. calculated using the Direct Plan-Growth option. Standard Deviation indicates Total Risk and
Sharpe Ratio measures the Risk-Adjusted Return. They are calculated over 3 years assuming a risk-free rate of 5% p.a.
Past performance is not an indicator of future returns.
*Please note, that this table represents past performance.
The securities quoted are for illustration only and are not recommendatory.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully. 

The table here shows how the returns of Medium-to-Long Duration Debt Funds have fared across time periods, where interest rates moved down and up as a function of RBI’s monetary policy actions over longer periods.

It is in the last year that Medium-to-Long Duration Debt Funds have delivered decent returns against the risk taken. But therein as well, not all funds are worth your hard-earned money, and therefore, prudent selection matters.

Going forward, it seems that bond yields would see limited upside given that we are almost near the peak of the current interest rate upcycle (see Graph 3).

Graph 3: The 10-year G-sec Yield Has Softened

Data as of January 31, 2024
(Source: Investing.com, PersonalFN Research) 

As of February 9, 2024, the 10-year G-sec yield is around 7.11%, softened further from January 2024. Later in the year, bond yields are expected to soften more due to the possibility of rate cuts by the major central bank, including the RBI, and led by inflows from foreign investors after the inclusion of Indian bonds in JP Morgan’s Government Bond Index-Emerging Markets and Bloomberg’s bond index from mid-2024.

This scenario would make it favourable to invest in Medium-to-Long Duration Debt Funds and unlock the growth potential, as yields and bond prices have an inverse relation.

Which Are the Best Medium-to-Long Duration Debt Funds to Invest in 2024?

Among the plethora of Medium-to-Long Duration Debt Funds, the three best ones to invest in 2024 are:

1) ICICI Pru Bond Fund;

2) Aditya Birla SL Income Fund; and

3) Kotak Bond Fund

Here are some details as to why these funds are among the best in the Medium-to-Long Duration Debt Funds sub-category.

Best Medium-to-Long Duration Debt Fund for 2024 #1: ICICI Pru Bond Fund

Launched in August 2008, this is one of the top-performing Medium-to-Long Duration Debt Funds that adopts a prudent investment approach to generate satisfactory yield and offer investors superior risk-adjusted returns without undue credit risk.

The primary objective of ICICI Pru Bond Fund (IPBF) is to generate income by investing in a diversified range of debt and money market instruments, ensuring an optimal balance of yield, safety, and liquidity.

IPBF mainly focuses on investments in sovereign-rated G-secs and high-rated corporate bonds. The allocation to these is typically around 50% to 100% of its net assets. Besides, it also invests up to 50% of its net assets in money market instruments such as Commercial Papers (CPs) and Certificates of Deposits (CDs). IPBF maintains a relatively lower allocation to private issuers, constituting approximately 6% of its portfolio.

Table 3: Top-10 Holdings of ICICI Pru Bond Fund

Data as of January 31, 2024
(Source: ACE MF, data collated by PersonalFN Research) 

As of January 2024, IPBF’s portfolio comprises 28 securities. The top 10 holdings comprise approximately 91.12% of the fund’s assets. In all, 81.3% of its net assets are in G-secs, 10.81% in AAA-rate corporate bonds, and 7.64% in cash-and-cash equivalents.

The fund generally maintains a portfolio duration of 4 to 7 years, in line with its medium to long duration category, and currently has a Macaulay Duration of around 5 years and an average maturity of 8.17 years. Average maturity here refers to the ‘weighted average maturity’ of all the underlying debt securities held by the fund.

The Yield-to-Maturity (YTM) of IPBF is 7.47% (as of January 2024 portfolio), which sheds light on the returns the fund is expected to generate if the underlying bonds are held until maturity. Note, the YTM may change as the fund manager buys and sells bonds in the portfolio.

In the last year alone, the fund achieved an absolute return of 7.60%, surpassing both the Crisil Composite Bond Fund Index and the majority of its category peers by a significant margin. Moreover, IPBF has consistently outperformed the category average, surpassing the index by a noticeable margin over longer periods of 3 to 5 years. In terms of risk-adjusted returns as well, IPBF has a respectable Sharpe Ratio of 0.08 and Sortino Ratio of 0.17 compared to some of its peers.

The overall performance of IPBF is influenced by the coupons and maturity of its portfolio holdings, as well as the credibility of the issuers. The fund’s performance is closely tied to interest rate movements across the maturity curve due to its investments in various maturity instruments.

It’s noteworthy that the fund experienced lower volatility during the recent rise in interest rates and is well-positioned to benefit from easing interest rates and the resulting bond market rally.

IPBF is managed by Ms Chandni Gupta (since December 2020) and Mr Rohit Lakhotia (since June 2023). Both hold credible experience and educational qualifications.

Best Medium-to-Long Duration Debt Fund for 2024 #2: Aditya Birla SL Income Fund

This is one of the oldest debt funds launched in October 1995 that has successfully navigated low-interest rates and is well-positioned to benefit from the rally in bond markets.

The primary investment objective of Aditya Birla SL Income Fund (ABSLIF) is to generate consistent income through superior yields on its investments at moderate levels of risk through a diversified investment approach. To accomplish this objective, ABSLIF mainly invests in highly rated instruments of medium to long duration while proactively steering clear undue credit risks.

The fund holds a diversified portfolio by allocating a substantial portion of its assets to medium to long-duration debt instruments issued by the government and public sector entities, with a smaller allocation to private sector issuers in the form of CPs and CDs. ABSLIF invests predominantly around 50% to 90% of its assets in Sovereign-rated G-secs of different maturities, along with an allocation of up to 30% in corporate debt instruments.

Table 4: Top-10 Holdings of Aditya Birla SL Income Fund

Data as of January 31, 2024
(Source: ACE MF, data collated by PersonalFN Research) 

As per the January 2024 portfolio, ABSLIF has a total of 39 securities spreading across high-rated issuers and maturities. The fund avoids any allocation to assets with moderate or low ratings and refrains from holding exposure to unrated instruments. As a result, this has helped ASBLIF somewhat mitigate credit and interest rate risks.

The current portfolio has 81.33% in G-secs, 13.12% in AAA-rate corporate bonds, 1.31% in CDs, 0.3% in AIF (which was added recently), and the rest in cash-and-cash equivalents. The top 10 holdings comprise approximately 91.23% of ABSLIF’s assets.

At present, ABSLIF’s Macaulay Duration stands at 6.40 years, while the average maturity is 9.11 years. So, a significant portion of its assets is invested in the longer maturity bucket of 5 to 10 years. The fund has increased its portfolio duration to benefit from the ease in interest rates, which could help potentially benefit from a bond market rally. That said, it also makes ABSLIF more sensitive to interest rates (especially in a rising interest rate scenario).

This has helped ABSLIF to maintain a decent YTM of 7.36%. If the fund buys and sells the securities, this YTM will of course change.

Over its 28-year track record since its inception in October 1995, ABSLIF has delivered approximately returns at 7.89% CAGR (as of February 9, 2024). The fund has provided respectable risk-adjusted returns, as is evident from the Sharpe Ratio and Sortino Ratio of 0.03 and 0.06, respectively.

ABSLIF seems strategically well-positioned to capitalise on subsequent bond market rallies. The fund has the potential to generate respectable yields, benefiting investors throughout an entire interest rate cycle.

ABSLIF has been managed by Bhupesh Bameta since August 2020, who has impressive education qualifications [B. Tech (IIT Kanpur), CFA Charterholder (CFA Institute, USA)] and a comprehensive work experience of over 13 years in the financial services industry.

Best Medium-to-Long Duration Debt Fund for 2024 #3: Kotak Bond Fund

Launched in November 1999, this is also one of the old debt funds that adopt a prudent investment approach to generate appealing yield and offer investors superior risk-adjusted returns without undue credit risk.

The primary investment objective of Kotak Bond Fund (KBF) is to create a portfolio of debt instruments such as bonds, debentures, Government Securities and money market instruments, including repos in permitted securities of different maturities, so as to spread the risk across different kinds of issuers in the debt markets.

In line with the objective, KBF has always held a predominant exposure (over 70%) to G-secs at most times, the rest in AAA-rated corporate bonds, and in cash-and-cash equivalents. Only very recently it added an AIF, wherein it holds 0.3% of its assets.

KBF holds over 30 securities in its portfolio across maturities, with a majority in longer maturity buckets of 7 to 10 years and 10 to 15 years. The fund has increased its allocation to these maturity buckets since November 2022. Given the higher allocation to longer maturity buckets, KBF is more sensitive to interest rates (especially in a rising interest rate scenario).

As regards the rating profile, KBF tries to keep its allocation to assets with moderate or very low ratings very minimal.

Table 5: Top-10 Holdings of Kotak Bond Fund

Data as of January 31, 2024
(Source: ACE MF, data collated by PersonalFN Research) 

As per the January 2024 portfolio, KBF has a total of over 30 securities, mainly spreading across high-rated issuers and maturities. The current portfolio has 80.39% in G-secs, 15.83% in AAA-rate corporate bonds, 1.39% in AA-rate corporate bonds, 0.25% in AIF (namely the Corporate Debt Market Development Fund), and the rest is in cash-and-cash equivalents. The top-10 holdings comprise approximately around 83.71% of the assets of KBF.

At present, KBF’s Macaulay Duration stands at 5.69 years (lower than its peers), but the average maturity is 13.21 years (higher than its peers) owing to higher exposure to longer maturity debt papers. The longer maturity exposures could help the fund when interest rates reduce and when we see a rally in bond markets. Nevertheless, it does not do away with KBF’s sensitivity to interest rates (particularly in a rising interest rate scenario).

The current YTM of KBF is an impressive 7.70%, but keep in mind this may change as the fund manager buys and sells securities.

In the last 1 year, KBF has clocked an absolute return of 7.18%, better than the Crisil Composite Bond Fund Index and the category average returns. Over its 24-year track record since its inception in November 1999, KBF has delivered approximately 8.30% CAGR (as of February 9, 2024). The fund has provided respectable risk-adjusted returns as is evident from the Sharpe Ratio and Sortino Ratio of 0.04 and 0.07, respectively.

KBF looks to be well-positioned for subsequent bond market rallies. The fund has the potential to generate respectable yields, benefiting investors throughout an entire interest rate cycle.

KBF has been managed by Abhishek Bisen since January 2013, whose education background is B.A. (Management) and MBA (Finance) from IIM-Calcutta and has experience in the bond markets spanning over two decades.

Who Should Invest in Medium-to-Long Duration Debt Funds?

Medium-to-Long Duration Debt Funds are suitable for investors with a slightly aggressive risk profile and a minimum investment horizon of 3 to 5 years.

So, if you are a conservative investor, prioritising the complete safety of their principal amount and are unable to tolerate near-term volatility and interest rate risk associated, then Medium-to-Long Duration Funds may be inapt for you. Over a period of 3 to 5 years, Medium-to-Long Duration Funds would reward you, the investor, well provided a thoughtful choice is made.

What Are the Tax Implications of Investing in Medium-to-Long Duration Debt Funds?

For all debt funds, with effect from April 1, 2023, the capital gain arising at the time of redemption — whether short-term (a holding period of less than 36 months) or long-term (a holding period of 36 months and above) — is taxed as per investors’ tax slab.

The indexation benefit that earlier helped to make the most of the inflation impact on the purchase value of the investment and effectively reduced the LTCG tax liability is now no longer available for Debt Mutual Funds.

[Read: Debt Mutual Funds are Now at Par with Fixed Deposits for Taxation]

For NRIs, the capital gains on debt-oriented mutual funds are subject to Tax Deduction at Source (TDS) at the rate of 10% for LTCG and 30% for STCG.

If you have opted for the dividend option (now known as IDCW option), for resident Indians, any dividends from Dynamic Bond Funds (under the Dividend Option) are added to the investors’ total income and are taxed according to your income-tax slab i.e., at the marginal rate of taxation. However, if the dividend amount is more than Rs 5,000, Tax Deduction at Source (TDS) will be first done at the rate of 10%. For NRIs, the dividend received is taxed at the rate of 20%.

To sum-up…

At a time when interest rates seem almost peak out in the current interest rate upcycle, Medium-to-Long Duration Debt Funds seem well poised and suitable for your portfolio — provided you have a moderate-to-high risk appetite and an investment time horizon of 3 to 5 years. It would be best to invest in these funds in a staggered manner to mitigate the interest risk. The level of risk shall depend on how well the fund manager understands and plays the interest rate cycle and the quality of debt papers held. Therefore, avoid simply looking at past returns and mutual fund star ratings.

Be a prudent investor. And when in doubt, speak to a SEBI-registered investment advisor.

Happy Investing!

This article first appeared on PersonalFN here