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Bond funds get their mojo back

Bond funds get their mojo back

Bond funds get their mojo back
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By Sumaira Abidi  Jun 8, 2018 5:28:06 PM IST (Published)

Bond yields have been on an uptrend for a while now and today topped 8% intra-day – a 4.5-year high.

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Bond portfolios have not made money for investors over the last 12 month but the trend of rising yields coupled with volatility in the equity market has lent significant sheen to debt funds.
Long considered a ‘retirement’ instrument, bond funds are back in vogue! Across the board, experts are recommending an allocation to bond funds.
Typically, the bond market factors in news ahead of an Reserve Bank of India (RBI) move and is currently working with the assumption that another rate hike is likely in either August or later this year.
Manoj Nagpal of Outlook Asia Capital says the best strategy at the moment is to either look at funds closer to the shorter end of duration or lock into yields.
According to him, the sweet spot currently is the three year fixed maturity plans, where you can lock in your money for a healthy return over the period.
This category focusses on the accrual strategy, which means buying similar maturity instruments and holding till redemption, thereby reducing the interest rate risk.
For those who want complete safety and no risk, Harshvardhan Roongta of Roongta Securities, recommends opting for a liquid fund.
A liquid fund typically consists of a portfolio where the residual maturity is 90 days. This means that should a rate hike come in August and the yield head higher still, your risk is limited.
He recommends investing into – ICICI Liquid Fund, Reliance Liquid Fund or the IDFC Money Manager.
With G-Sec yields at 8%, experts believe that net of expenses, investors can expect returns of 7.5% on their debt funds.
7.5% is not bad, but there are always investors who looking for more alpha. This is where the credit risk funds come in. Returns from AA paper are outpacing their more reliable peers.
With the growth momentum picking up, corporate earnings improving and capex recovery on the horizon, the possibility of AA paper getting upgraded rises and this re-rating helps returns.
Here, Manoj and Harshvardhan both seem to favour the ‘Franklin Templeton Credit Risk Fund’.
R Sivakumar, Head, Fixed Income at Axis Mutual Fund, says that while he expects credit to keep outperforming, he does caution investors to keep away from the riskier bonds.
But is it time for all debt fund investors to rejoice? Those who have bought, when yields were closer to 7% or lower, may experience a sour taste in their mouth.
This is because interest rates and bond prices are inversely related. This means when interest rates go up, bond prices go down and take the net asset values (NAV) south too.
That said, the impact is greater on funds which are holding paper with a longer duration. But, fear not, the negative is limited to the capital loss on the prices as on date. This means, that unless booked, it’s a notional loss currently.
Rising interest rates fuel investor appetite for risk-free returns. They value the safety of debt over the returns from equities.
But, make no mistake, risk free status does not make debt funds the equivalent of bank fixed deposits as is often perceived.
Here’s why: the assumption is that debt mutual funds behave similarly to bank fixed deposits (FD), but they don’t!
They are in fact exact opposites. For example, if interest rates go up, an FD investor can re-book their FDs at a higher rate and start earning better return.
But as the previous paragraphs proves, an existing debt fund investor feels no joy with rising rates.
It’s worth noting that recently Securities and Exchange Board of India (Sebi) rules have carved out 16 categories of debt funds.
This classifies investments according to maturity and the risk associated with the underlying.
Lowest risk category includes liquid funds and it moves up the ladder to duration of 10-30 years.
If redeemed after three years, an investor has to pay 20% Long Term Capital Gains with indexation benefit. However, if the holding period is less than 3 years, you have to pay tax according to relevant tax rates.
Experts also caution that retail investors stay away from trying to play the interest rate cycle.
Bond funds should be considered for their original purpose – a ‘safe’ way to park money. They are not an instrument of active trading.

Please consult a personal finance advisor before making changes to your portfolio

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