Fresh investments can be considered in the units of Templeton Income Builder Plan B (Income Builder).
Income Builder is amongst the top performing debt funds over the last three-year period. The fund returned 12.4 per cent and 8.6 per cent in one- and three-year periods as compared with 9 per cent and 6.9 per cent returned by CRISIL Composite Bond Index. The fund bet on non-AAA rated corporate bonds which helped it emerge as the top performing long-term bond fund in the last one year.
The fund is suitable for investors whose risk appetite is high. It can be considered as an alternative to riskier non-banking finance deposits.
Investors need to hold on to the units for more than two years to benefit from decline in interest rates and credit spreads. Debt funds are much more tax efficient than fixed deposits, given that their returns are subject to capital gain tax at 20 per cent after indexing for inflation. The inflation index grew by 10.4 per cent in the last three financial years. Therefore, on any returns less than 10.4 per cent, investors need not pay capital gain tax. On the other hand, investors will be taxed at their marginal rates in the case of deposits.
Strategy
As the fund predominantly takes exposure to non-AAA bonds, it tends to deliver higher returns than other bond funds which bet mainly on AAA-rated debt. For instance, current AA yields are 50 basis points higher than the AAA bond yields. The similar-rated securitised debt will have another 50-75 basis points premium to debentures.
On the flip side, during events such as the global credit crisis and rising interest rate cycles, risky debt instruments tend to under-perform high quality bonds. The fund had underperformed its benchmark during the year 2008-09.
However, the current environment seems quite conducive to bet on the Income Builder as the interest rates seem likely to decline. This may not just reduce credit risk on lower rated bonds, it may also trigger a rise in the bond prices. Given that the fund’s duration (measure of interest rate risk) is close to four years, the value of the portfolio can rise significantly if the rates decline. Strong interest accruals, coupled with capital gains due to fall in interest rates, will improve the total return of the fund.
Funds such as Income Builder also bet on securities which have potential for ratings upgrades. The fund is actively managed which allows it to take advantage of any mis-pricing of securities. The risk-adjusted return (sharpe ratio over the last three years) of the fund is positive, indicating that active management has worked in the past.
Performance and portfolio
On a one-year rolling return basis, the fund has outperformed the index 73 per cent of the times over the five-year period. It has also actively shifted between AAA and other debt instruments depending on market conditions.
After non-AAA exposures led to the fund’s under-performance in 2008, it significantly reduced exposure to such instruments. Instead, it relied on top rated debt until October 2011 when it once again began upping its exposures to non-AAA rated debt.
As of November 2012, close to three-fourth of the portfolio was invested in non-AAA rated corporate bonds and structured products. The yield to maturity as of the portfolio is around 10.3 per cent which is more than 2.2 percentage point spread over the government bond yields.
Thanks to strong performance, the average assets under management of the fund have risen to Rs 359 crore from Rs 62 crore a year ago.