duration funds

Time to take a call on duration funds

Debt mutual funds, broadly, follow one of the two strategies. One type of fund aims to make money out of predicting interest rate movements. Accordingly, it will buy and sell securities to have a particular maturity date of the portfolio. This strategy is called duration strategy. The second type of fund aims to invest in companies that have a lower credit rating but are well-managed. The intent here is to buy those companies where the fund manager expects credit ratings to improve, which will hopefully lead its price to go up and benefit the fund. This strategy is called accrual strategy. Many debt funds follow a bit of both strategies, depending on what their market view is. Choosing one over another has a bearing on the returns you could make and risks you take on.

The RBI has on 6th June 2019 cut repo rate by 25bps to 5.75%. Repo rate slips to the lowest level since July 2010. Now we have had three consecutive rate cuts (February, April, June). We have also seen the 10 year g-sec fall by over 100 bps over the last one year to below 7% currently.

More importantly the RBI has changed its policy stance from neutral to accommodative . This basically means that there is unlikely to be any rate hike in the near foreseeable future. With inflation largely in control, there could be further 1-2 rate cuts in the next one year, if slowdown persists. This assurance should be a major positive for the duration funds category.

A falling interest rate scenario is beneficial to debt mutual funds because of the inverse relationship between yields and price of bonds. When there is a rate cut, the price of bonds goes up. This pushes up the NAV of debt mutual fund schemes.

Most of the worries for the debt market have overturned in the last few months. FED changed the outlook to dovish surprisingly, inflation came down and oil prices came down from $75 to around $60/ barrel. All of this has overturned the fortunes of the long duration debt schemes.

All this might add to the rally in the long duration bond funds and other long term debt funds like gilt funds. Investors can invest in these schemes with a medium term horizon of three years at least. We believe that these schemes will continue to offer double-digit returns for a year. But given the current situation of defaults, staying at the shorter end with dynamic bond funds in your portfolio would also be a good/safer strategy.

The Gilt & long duration bond funds categories are offering 10-12% returns in one year, 5-6% in six months, and 4-5% in three months. With the BJP coming back to power we are expecting the interest rate trajectory to remain subdued over the next few years. Maybe is it time for mutual fund investors to start betting on them.

Debt Mutual Fund: Duration Funds vs Accrual Funds

Liquid Fund vs Savings & Current Account

Scheme NameInception DateNAVRisk Return
1 Month3 Months6 Months1 Year3 Years
ICICI Pru Long Term Bond Fund(G)09-Jul-199860.973.575.696.5212.729.75
IDFC Bond Fund – Inc Plan-Reg(G)14-Jul-200045.572.804.715.4011.248.51
SBI Magnum Gilt Fund-Reg(G)23-Dec-200041.932.954.875.9410.839.63
HDFC Gilt Fund(G)25-Jul-200137.881.702.664.569.237.70
ICICI Pru Gilt Fund(G)19-Aug-199964.932.033.575.539.469.13
Reliance Gilt Securities Fund(G)22-Aug-200825.623.055.046.5912.8510.53
UTI Gilt Fund-Reg(G)21-Jan-200241.932.394.526.1710.2110.37
Kotak Gilt-Invest-Reg(G)29-Dec-199864.222.334.085.6710.978.33
IDFC G-Sec-Invest-Reg(G)05-Dec-200822.913.065.806.9913.579.74
DSP G-Sec Fund-Reg(G)30-Sep-199961.202.804.876.4412.349.25
Franklin India G-Sec Fund(G)07-Dec-200142.592.844.516.4512.006.88
Tata Gilt Securities Fund-Reg(G)04-Sep-199954.072.784.334.9811.677.75
Aditya Birla SL G-Sec Fund(G)11-Oct-199953.592.774.115.6411.909.94

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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