‘There is a debt fund to suit every time frame'

Did you know that mutual funds offer debt products to suit your different investment horizons?

Mr Anupam Joshi, Associate Director – Fixed Income, IDFC Mutual, explains the characteristics of various debt funds available to investors and over what investment time frame they are suitable.

Excerpts:

Is it time to look for long-dated funds for investment?

On a pure accrual basis, if I were to present you an 8.5 per cent 10-year government security for a one-year investment vis-à-vis a 10 per cent one-year bank certificate of deposit, your 8.5 per cent gilt has to move down by at least 35-40 basis points for it to deliver a 10 per cent return over a year.

That is why we keep saying that on a risk-adjusted basis — that is, the amount of risk you take for every rupee invested in a fixed income instrument — the return pay-off is significantly in favour of the front end of the curve or short-term debt instruments.

But having said that, the mantra for this financial year for investors would be to look for actively managed funds like a dynamic bond fund, rather than passively managed funds.

Can you explain what funds will suit retail investors across various time frames?

For simply parking money for 1-7 days, we would recommend liquid funds. For 15 days to 30 days, we recommend an ultra short-term fund.

The average maturity of their portfolio is around 90-120 days. So the interest risk is very limited and a bulk of the returns comes from accrual income of the portfolio.

The underlying credit quality too is strong because the bulk of the portfolio remains invested in bank certificate of deposits.

In our short-term funds, the investment horizon is six months-plus. The typical average maturity of the portfolio will be around two years at all points in time. The portfolio will be a mix of bank CDs and short-term bonds. The interest rate risk in this is higher compared with an ultra short-term fund.

Further on the curve comes the medium-term fund. Now this is a product where we actively manage in such a way that up to 25 per cent of the portfolio can get invested in an asset class that can deliver an alpha over the next three-six months.

For instance, in our medium-term fund, we also have leeway to participate in gilt when the opportunity arises to make money tactically.

So you can say this is a part-actively managed fund wherein the interest risk is significantly higher than a short-term fund as the average maturity can go higher. The recommended investment horizon for this is 9 months-plus.

On the longer end of the curve we have two products — a super saver income fund-investment plan and a dynamic bond fund.

The former is typically categorised as a passive income fund. We do not recommend retail investors to be in passive funds now.

What if an investor wants the best of short and long instruments?

What we are recommending for such investors now is dynamic bond fund. As the name suggests, the architecture of the fund is such that there are no constraints either on the average maturity or on the asset classes (within debt) that this fund can invest in. This fund may choose to run 100 per cent bank CDs or shift entirely to gilt based on opportunities.

But this will be categorised as high risk wherein the volatility of returns is going to be significantly higher. The recommended investment horizon would be one year-plus.

What would you recommend for an investor who wants to add a debt fund now to his portfolio with a time frame of, say, five years in mind?

In a market like India, we will always have small patches of secular moves in interest rate markets. For example, between 2008-09, for a phase of six months, we had a secular bull run when the RBI reacted very positively in terms of cutting the interest rates.

Between March 2009 and December 2010 we had a secular bear market where rates kept on rising over a period of time. Remember seven years ago, in 2005, we had 10-year gilts trading at somewhere close to 8 per cent.

So if you had invested in passive funds then, they may not have returned enough to even beat inflation. So if you are now going to witness similar or increased volatility in interest rates going forward, a passively managed interest rate fund is likely to under-deliver an actively managed one.

For a five-year plus investment horizon, we would recommend an actively managed debt fund or a short-term fund.

What kind of debt funds will fit senior citizens?

Here again, it has to be in line with investment horizon and risk appetite.

So for a 70-year old man who is not looking to meet any key goals such as marriage or education expenses of grand children within, say, 12 months, I would recommend a product such as FMP which is not liquid but will give better returns than open-ended funds. If such as person requires liquidity, then an open-ended product is more suitable than an FMP.

Should investors use SIP in debt funds?

For a salaried individual who wants to save some amount every month for future requirement without taking any incremental risk, rather than leaving the money in a savings account, liquid fund or an ultra short-term fund are better options.

But in a product like dynamic bond fund, the only concern is that it is pro-fund manager. So your fortunes are linked more to the decisions of the fund manager than to the interest rate outlook.

So if you have faith in a fund manager you could look to systematically participate in the fund for the next 5 or 10 years.

But using SIP as a tool may be better in funds such as ultra short-term schemes wherein the goal is to keep money safe, liquid and generate returns over and above savings bank returns.