What are Short Duration Bond Funds?Short duration bond funds are bond funds with specific mandates to invest in fixed income that are short duration (usually with a duration of less than 3 years).
Malaysia short duration bond funds are rated Risk Rating 1, which are 1 notch higher than money market funds (Risk Rating 0) and 1 notch lower than general bond funds (Risk Rating 2) which do not have mandates to invest in bonds with specific maturities.
The lower the duration, the lower the bond’s susceptibility to interest rate increases. The risk rating is meant to illustrate that short duration bond funds are of higher risk than money market funds but lower risk than general bond funds.
When to invest in Short Duration Bond Funds?Nevertheless, at the time of writing, short duration bond funds offer exposure to a “sweet spot” within the bond space: by taking on slightly more duration risk compared to a money market fund, investors can receive a reasonable yield while also minimising the risk of losing money when interest rates ultimately rise from their current depressed levels.
If an investor believes that interest rates are going to rise, then one could choose to invest in a fixed income fund with a short duration (primarily comprised of short duration bonds), minimizing the effect of a potential rise in interest rates on the investor’s portfolio’s fixed income portion.
On the other hand, should an investor believe that interest rates are poised for a fall; they could invest in a fixed income fund with a longer duration (primarily comprised of long duration bonds) for the fixed income portion of their portfolio.
Thus, investors can reduce their interest rate exposure by investing in short duration bond funds.
ConclusionThe current low-interest rate environment poses a problem for savers, who now find that bank deposits offer negligible returns on their savings. On the other hand, the lower-risk nature of savings means that it is also not practical to park these funds in an equity fund or high yield bond fund (which can offer significantly stronger potential returns), given the fairly high investment risk inherent in both.
For investors who are seeking superior returns compared to fixed deposits and savings but are unwilling to take on too much investment risk, short duration bond funds may be the answer.
This post has been edited by ironman16: Apr 8 2021, 08:59 PM