The portfolio credit quality of this relatively new genre of debt funds is commendable
The fundamental approach to building one’s investment portfolio is to have an appropriate allocation to equity, debt and any other asset you may want to have, for example gold. The basic premise is that the different investments i.e. equity, debt and gold have different profiles of variability in returns; in other words, volatility is a given. By making appropriate allocations, you bring about balance in your investment portfolio, also known as ‘optimising’.
The appeal of debt mutual funds in the overall picture is that it is relatively less volatile than equity, but yields lower returns in comparison. In other words, the relatively more stable component of your portfolio is debt. In India, it is known as debt investments, but abroad it is called fixed income investments as there is a fixed coupon or interest on the instruments.
To be noted, in fixed income mutual funds, returns are not fixed as such as it moves along with the market, but it sees lesser volatility than equities.
On debt funds, there are two concerns that people have. One, what if interest rates move up? Mind you, interest rates moving up is not the same as equity stock prices moving up.
When bond interest rates move up in the secondary market, bond prices come down, and consequently the NAV of your debt mutual funds are impacted. Somewhere down the line, the RBI will have to raise interest rates from the very low levels of today, which would rather be rate normalisation than increases in the usual sense of the term. Typical debt fund investors expect visibility on returns, like with a bank fixed deposit.
The other concern among investors is about the credit quality; the incidents of credit defaults that happened earlier are avoidable. In this backdrop, is it possible to have a debt fund that cushions against volatility risk when interest rates move up, have a very high portfolio credit quality and also provide some visibility on returns? There is a relatively new genre of debt funds called Target Maturity Funds (TMFs).
‘Hold till maturity’
There is only one minor condition — you have to hold the fund till maturity. But do not worry about this condition — there are multiple funds available with various maturity dates. If you require liquidity prior to maturity, that is available.
Let us understand the concept of TMFs. As the name suggests, there is a target or a stated date on which the fund would mature. Upon maturity, money flows back to the investors. TMFs are similar to fixed maturity plans (FMPs), in that they mature like a bond or a bank fixed deposit.
However, TMFs are significantly better than FMPs. The drawback of FMPs is that though it is listed on the exchanges, there is no liquidity. If you intend to sell prior to maturity, you may not get a buyer. Moreover, the usual maturity of FMPs is three years. This means that the choice of investors is limited to a one time horizon.
We will mention in a while, the various TMFs available and their maturity dates. Accordingly, you can space out your investments. The other aspect of TMFs to understand is how these funds are structured. An Index Fund is one that follows an index, and the fund manager does not play an active role in fund management. An Index Fund could be an equity fund based on, say, the Nifty or the Sensex. In debt TMFs, the index is custom-built as these funds do not follow an existing index but have a particular mandate.
The indices for TMFs are run, in most cases, by the NSE, and sometimes by Crisil.
The other structure on which a TMF can be built i.e. other than the Index Fund format, is the Exchange Traded Fund (ETF). In this structure also there is an index to be replicated. The difference is, units of ETFs are listed on the exchanges. You cannot purchase from or redeem with the AMC, which you can do with other funds, including Index Funds.
You can purchase/sell ETF units on the exchange, similar to how you transact in equity stocks. Liquidity is generally there in ETFs; at least it is better than with FMPs. The condition here is similar to trading in equity shares: you need to have a demat account and an account with a stock broker.
Not a tough ask, but some like senior citizens or people who are not used to it may prefer TMFs structured as Index Funds. In Index Funds, you can transact in the units in the normal course with the AMC, like you do in other funds.
‘Different shades of value’
The portfolio credit quality of TMFs is top notch. To understand this, we have to see the available classes of debt securities. The best instrument is the one issued by the Government of India, popularly known as G-Secs. A more-or-less similar category, is the one issued by State Governments, called SDLs. SDL stands for State Development Loans. Then, we have bonds issued by PSUs that have the highest credit rating, which is ‘AAA’.
In the Index Fund format, for example, ICICI Prudential AMC has come out with an NFO called PSU Bond plus SDL 40:60 Index Fund — Sep 2027. The portfolio comprises 40% AAA-rated PSUs and 60% SDLs. We have IDFC Gilt 2027 Index Fund and Gilt 2028 Index Fund, portfolio comprising G-Secs. Maturities of these funds are 6-7 years from now, and you can redeem easily if you require liquidity earlier.
The portfolio yield of ICICI is a little higher than IDFC as G-Secs carry rates that are slightly lower than SDLs or PSU bonds. In the ETF format, there are Bharat Bond ETFs of various maturities — April 2023, April 2025, April 2030 and April 2031; portfolios comprise AAA-rated PSU bonds.
(The writer is a corporate trainer and author)
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