• Macaulay duration is the weighted average of the period the investor should remain invested in the security in order to have the present value of the cash flows (interest and principal payments) from the bond matching the amount paid for the bond. Longer the maturity of a bond, longer is its Macaulay Duration. Macaulay duration is directly related to the interest rate sensitivity of a fixed income security. Bond prices rise when interest rates go down and vice versa. The price sensitivity of low duration funds to interest rate changes can be moderately low to moderate. These funds can be more volatile than liquid and ultra-short duration funds, but less volatile than short duration, medium duration and long duration funds. Investors should invest according to their risk appetites.
• Low duration funds usually hold the securities in their portfolio till maturity; this is also known as accrual strategy. If you hold a fixed income security till maturity, then volatility caused by interest rates will have no impact on your returns since the issuer (borrower) will pay you the principal amount on maturity, along with periodic interest (coupon) payments. Hold to maturity or accrual strategy also provides a certain degree of visibility in returns.
• The yield curve (yields for different maturities) of bonds is usually upward shaping i.e. bonds of longer maturity / durations give higher yields than bonds of shorter durations. As such, low duration funds have the potential of giving higher returns than liquid and ultra-short duration funds over sufficiently long investment horizon. The yields of low duration funds also depend on the credit quality of the scheme’s underlying portfolio. We will discuss this in more details later.
• Investors can also get the benefit of NAV (price) appreciation in a favourable interest rate regime (falling interest rates). However, the level of price appreciation in favourable interest rate regime for low duration funds will be lower than longer duration funds.
• Yields of fixed income securities depend on the credit rating of the securities. Lower rated papers give higher yields than higher rated papers. Schemes investing in lower rated papers may give higher returns than schemes investing in higher rated papers but investors must be aware of credit risks when making investment decisions. Lower rated papers have higher chance of credit rating downgrade or default. You should see the credit quality of low duration funds and make sure that you are comfortable with the credit risk before investing.

• Investors who have investment tenures of at least 6 to 12 months can invest in low duration funds. You should be prepared to remain invested for at least 6 months for low duration funds. You can invest for longer tenures but your final returns will depend on yield movements over the investment tenure.
• Investors who want income with relatively low volatility over longer investment tenures can also invest in low duration funds. For income, you can opt either for Systematic Withdrawal Plan or Dividends (now known as Income distribution cum capital withdrawal or IDCW) depending on your tax situation.
• If you want to invest in an equity fund but are worried about short term volatility, you caninvest in low duration fundof the same fund house and invest in the equity fund through Systematic Transfer Plan (STP) from the low duration fund. In this way, you can get more liquidity and returns from the low duration fund and take advantage of the equity fund volatility through rupee cost averaging. Low duration funds are suitable for STPs because they are less volatile than longer duration funds.

• You should ensure that your investment tenure matches or exceeds the maturity profile of the scheme. We had discussed earlier that low duration funds holds securities till maturity. If your investment tenure matches / exceeds the maturity profile of the scheme then adverse interest movement will have no impact on your returns.
• Many investors had the misconception that credit risks applied mostly to schemes investing in longer dated (longer maturity) papers (corporate bonds, NCDs etc.). But credit events over the last couple of years have shown that even shorter duration funds (e.g. low duration funds) are subject to credit risks. Credit risk can cause permanent loss and should be one of the most important considerations in selecting debt schemes. You can check the credit quality of a debt scheme in the fund factsheet or the scheme information document (SID).
• Total Expense Ratio (TER)is another important factor to consider when selecting low duration funds. Since the yields of these funds are on the lower side compared to longer duration funds, high TERs will have an impact on the performance of these schemes and your post tax returns especially in a low interest rate regime. You should consult with your financial advisor and make informed investment decisions.

The taxation of low duration funds depends on how long you stay invested in this fund. If your investment tenure is less than 3 years, the capital gains will be added to your income and taxed according to the applicable income tax slab rate. Long term capital gains (investment holding period of 3 years or longer) will be taxed at 20% after allowing for indexation benefits. Dividends(now known as Income distribution cum capital withdrawal or IDCW) paid by low duration funds will be added to your income and taxed as per your income tax rate.