ICICI Prudential Life Insurance launched a debt fund on May 15, 2023, which is a constant maturity fund with a maturity of around 10 years.
The fund is available for ULIP investors and is aimed at investors wishing to lock in yields and gain from possible price growth from interest rate movement.
The ability to lock into yields in constant maturity funds, the prevailing gilt yields and loss of indexation benefit in other debt MFs are positive attributes of the fund.
Lower interest rate risk, but priced in
For bonds, interest rate risk is central to returns. A rate hike by RBI implies that older bonds trading in the market will incur price loss as bonds with higher coupons are now available. On the face of it, this primary interest rate risk is significantly lower in the current environment.
With a 250 basis points rate hike by RBI in under a year, the probability of further rate hikes should be lower. The inflation print is also easing, allowing RBI to maintain a pause on rate hikes in February this year.
However, while from the current vantage point, anticipating a rate cut would be premature, in 10 years, since interest rates move in cycles, the fund will be positioned to capture the gains from the cut as well.
That said, is it a good time for a constant maturity fund launch? Constant maturity funds are held till maturity to secure yields. The fund would invest predominantly in government bonds maturing in 10 years.
By holding till maturity, the fund would be able to secure the yields at which the instruments are currently trading. However, the 10-year government bond yields (inversely related to prices) have come off from 7.62 per cent last June, or an average yield of 7.32 per cent in the last one year to 6.96 per cent now.
Thus, while the fund can capture higher yields of around 7 per cent and further price appreciation, the initial gains have been discounted by the markets.
The fund also invests a smaller portion in corporate yields. The spread of corporate yields to government securities is low according to the fund managers.
As the spread widens the proportion would increase, but still at a smaller portion of the fund, to maximise returns for the investors.
Tax implications
From a tax perspective, the differential between ULIPs and debt funds has come down, favouring ULIPs. Annual contributions to ULIP premiums are eligible for Section 80C deductions. The benefit though is limited, as the bracket is overcrowded with options.
The maturity benefits are taxed according to tax slabs for policies with premiums above ₹2.5 lakh. On the other side, the recent finance bill introduced tax changes that have eliminated indexation benefits to debt mutual funds.
All capital gains would be taxed at your slab from April 1 reducing tax differential in this segment.
The product has a lock-in for five years with an option to switch between plans. The constant maturity fund coming somewhat close to the peak of the interest rate cycle allows for securing higher real returns and thus is focussed on capital preservation.