Medium and Long Duration Funds — Where Debt Stops Feeling Steady

Debt categories are largely defined by how long their holdings run, which our page on short duration funds sets out as a ladder from overnight upwards.

Medium duration schemes hold paper running for a few years. Medium to long duration schemes run longer still, and long duration schemes hold bonds with many years remaining. Each step up increases how much the value reacts to a change in rates.

So these are not simply bigger versions of the categories below. They behave differently, and the difference becomes visible precisely when rates move.

A bond pays a fixed amount. If rates in general rise, a bond paying the older, lower amount is worth less to anybody buying it now, so its price falls.

How far it falls depends on how long that disadvantage lasts. A bond maturing next year is at a disadvantage for one year. A bond maturing in twelve years is at a disadvantage for twelve, so its price has to fall much further to compensate. Our page on gilt funds explains the same mechanism with government paper.

The reverse is also true. When rates fall, long bonds rise more. That symmetry is what makes the category attractive to some people and uncomfortable for others.

Worth describing concretely, because it is the experience that catches people out.

A period of rising rates can produce a decline in a long duration scheme lasting several months, visible on every statement, without a single borrower missing a payment. Somebody who chose debt because they wanted to stop seeing red numbers may find the red numbers are back.

The recovery tends to be slow as well. Once rates settle, the scheme continues to earn the interest on its holdings, and that gradually makes up the ground, but it can take a year or more rather than weeks.

Nothing has gone wrong in that situation. The scheme holds what it says it holds, and the price of those holdings has moved in the way long bonds do. The question is whether the investor horizon is long enough for that to pass, which our page on risk and volatility frames as the difference between movement and loss.

Duration describes how long the bonds run. It says nothing about who issued them.

Some schemes in these categories hold mostly government and top-rated paper, so interest rate movement is the main variable. Others hold a share of lower-rated debt as well, adding a credit risk that can arrive suddenly, as our page on credit risk funds explains.

A scheme combining long duration with weaker credit is carrying two separate risks at once, and the category name tells you about only one of them. The credit rating breakdown on the fact sheet tells you about the other.

A long duration scheme stays long. It holds long bonds whatever the manager thinks rates will do next, because that is what the category is.

A dynamic bond scheme can shorten or lengthen its holdings according to the manager view. That removes the fixed exposure and replaces it with a rate call, which may or may not be right.

So one gives you a known, large sensitivity to rates. The other gives you a variable one decided by somebody else. Choosing between them is choosing whether you want to take the rate exposure deliberately or delegate the decision.

A narrower group than the word debt suggests.

Somebody with a genuinely long horizon on the stable side of their portfolio, who accepts that the value will move noticeably and who will not need to sell during a period of rising rates, has a coherent reason. Some investors also hold long duration deliberately as a partial counterweight to equity, since in some conditions the two move differently.

What does not make sense is using this category for money with a near date because it is labelled debt. That is the mismatch our page on asset allocation exists to prevent, and a target maturity scheme or a shorter rung usually serves a dated goal better.

Three situations, and the first is the one we see most.

Money needed within a couple of years. A rate rise during that period lands on the whole holding with no time to recover.

The emergency buffer, which must be available at a known value. The very short end of the ladder or a deposit is the answer, as our page on building an emergency fund covers.

Anybody who chose debt to stop watching the value. That person will be unsettled by this category, and a shorter rung will serve them better.

• Is your horizon longer than the scheme typical holding length?
• Could you sit through several months of decline without selling?
• What is the credit quality, alongside the duration?
• What are the expense ratio and exit load, and the tax position at your holding period, which our page on mutual fund taxation covers structurally?

We are distributors rather than investment advisers, we recommend no schemes, and we hold no view on where interest rates are heading. Our comparison of equity and debt funds covers the wider split. If you want to check how much rate exposure your debt holdings carry, get in touch.