accrual funds

Accrual funds: a great contrarian bet

The widening spread between accrual funds’ YTM and repo rate offer an attractive entry at the moment. Based on valuations, sentiments and industry flows, accrual schemes make a good buy at this juncture.

Historically we have seen that whenever the spread between YTM and repo rate has been high, accrual schemes have given good risk-adjusted returns to investors. There is good contrarian investing opportunity available for accrual schemes as the elevated yield due to credit concerns provides a good margin of safety.

Absolute interest rates in the markets are higher as compared to the relative repo rate. So, today if you have 2-3 years AAA PSU bonds which are yielding close to 8% or blue chip companies like HDFC & Bajaj Finance Ltd providing marginally higher rates, overnight bond is giving around 6%. Normally, this kind of spread only happens in very tight liquidity environment in rising interest rate scenario. The fact that you are getting it in a falling interest rate scenario is a brilliant opportunity for investors to get deployed in good quality AAA rated papers.

On the other hand with credit defaults piling up, it is clear that the malaise in debt funds runs deep. Besides the IL&FS blowout, downgrades in DHFL, Essel, ADAG and YES Bank, among others, have hit debt funds hard. Any gain from rate cuts offer little respite to investors who have seen their funds’ NAVs erode sharply. The most recent downgrade in DHFL securities saw bond funds losing up to 53% of their NAV in a single day. Unless they are able to recover some money from DHFL in the coming days, it will take many years for these debt funds to regain their lost value.

While some fund houses will tide over the problems by merging affected schemes with larger funds, the entire episode presents a moment of truth for investors. It is time to get back to the drawing board and re-assess one’s debt fund portfolio. Avoid any bond fund whose portfolio now stands over-exposed to a single issuer owing to redemptions. Currently, the gaps between the higher and lower-rated funds have widened and the difference in interest rates offered by AAA-rated and AA-rated bonds has become around 150 bps. So, investing in credit-risk funds could be an extremely high risk high reward ratio. Personally I feel the 150-200 bps additional returns at the cost of double digit portfolio declines in case of defaults is not worth the risk. Thus investors should stick to funds with well-diversified portfolios, with a tilt towards AAA or similarly rated securities.

Scheme NameInception DateNAVRisk Return
AbsoluteAnnualized
1 Month3 Months6 Months1 Year3 Years
Aditya Birla SL Corp Bond Fund(G)03-Mar-199772.8431.513.005.059.758.75
Franklin India Corp Debt Fund-A(G)23-Jun-199766.62631.242.254.839.079.27
HDFC Corp Bond Fund(G)29-Jun-201021.17061.733.305.5210.008.84
ICICI Pru Corp Bond Fund(G)11-Aug-200919.3981.453.005.019.108.28
IDFC Corp Bond Fund-Reg(G)12-Jan-201612.8991.112.434.678.888.32
Kotak Corporate Bond Fund(G)21-Sep-20072511.10481.382.775.039.208.87
L&T Triple Ace Bond Fund-Reg(G)31-Mar-199747.58753.265.066.2210.877.53
HDFC Banking & PSU Debt Fund(G)26-Mar-201415.26831.352.705.199.727.68
Axis Banking & PSU Debt Fund(G)08-Jun-20121770.6491.442.595.5410.417.96

 

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Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 10 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’

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