Dynamic bond funds are ideal for investors unable to gauge interest rate movements prevalent in the market. Jiju Vidyadharan, senior director, Funds and Fixed Income Research , CRISIL, in an interview to Saikat Neogi says, medium-risk takers should look at dynamic bond funds and short-term debt funds while low-risk takers can look at ultra-short term and liquid funds. Edited excerpts:
How should individual investors look at liquid funds at a time when interest rates on savings bank accounts are dropping?
The CRISIL-AMFI Liquid Fund Performance Index has returned 6.71% in the past one year ended August 31, 2017 compared to 3.5-4% by most savings bank accounts. Investors should note that liquid funds also provide commensurate safety and liquidity of investments. Investments are in treasury bills, highest rated money market instruments and cash equivalents. Interest rate risk is low as investments are in papers with maturity of 91 days or less. Sebi’s recent measure to allow instant redemption of Rs 50,000 or 90% of portfolio value, whichever is lower, is an added benefit for liquid fund investments.
Given rising headline and core inflation, RBI may not cut interest rates at its October meeting. As such, should investors stay invested in long duration funds?
Long duration funds such as income and gilt funds are sensitive to interest rate changes, benefitting during declines and adversely affected during rate upsurges. Timing of investments is key to benefit from these funds. For instance, long duration funds measured by CRISIL-AMFI Income Fund Performance Index and CRISIL-AMFI Gilt Performance Index gave 10.3% and 11.8% annualised returns, respectively, between October 2014 and August 2017 (the latest phase of monetary easing). Since it is difficult to time entries and exits from these funds, investors are better off investing over the medium term (3-5 years) to derive optimum tax-adjusted (indexation) benefits. Income and gilt funds have given 7.67% and 7.44% annualised returns, on average, respectively, for 5-year holding period on a rolling basis since April 2000.
Does investing in dynamic bond funds make more sense now as these funds invest across instruments of various maturities?
Dynamic bond funds, as the name suggests, are ideal for investors who are not able to gauge interest rate movements prevalent in the market. These funds dynamically alter allocations between long-term and short-term bonds to take advantage of the direction of interest rates. In the past five years, these funds have shifted average maturities from as low as 4 years to 13 years, highlighting their ability to tactically change strategy based on rate calls. Dynamic bond funds are, therefore, an option for consideration in periods of uncertainty.
Often investors redeem from dynamic bond funds after seeing volatility in the short term. What should be an ideal holding period of such funds?
Despite tactical management, dynamic funds are still exposed to interest rate risk. Thus, investors with a medium-term horizon can consider investing in these funds.
In the last few quarters, balanced funds are seeing a lot of traction in terms of inflows. Going ahead, how do you see the performance of this category?
Balanced funds have benefitted from positive undercurrent in the invested asset classes, especially equity. This has resulted from the benefits of diversification into equity (typically 65-80%) and debt (20-35%). The equity allocation provides the impetus for returns and the debt component the safety during equity market downturns. Interestingly, the category (represented by CRISIL-AMFI Balance Fund Performance Index) has outperformed pure equity funds (represented by CRISIL-AMFI Equity Fund Performance Index) over 10 years ended August 31, 2017 by giving 12.4% CAGR compared with latter’s 11.7%. The benefit of diversification is expected to provide good stead for the category in the long term.
What are the risk and reward factors to look at before investing in debt funds?
Unlike plain vanilla fixed income products such as bank fixed deposits, debt funds do not guarantee returns as they are market-linked products. Hence, investors in these funds are exposed to primarily three risks—interest rate, liquidity and credit risks—based on the category invested in. As high reward comes with high risk, investors having higher risk appetite can look at credit funds (has high credit and liquidity risk) and longer-duration funds such as income and gilt funds (high interest risk). Medium-risk takers can explore dynamic bond funds and short-term debt funds while low-risk takers can look at ultra-short term and liquid funds. Investors should note that choice of category should be based on their risk profile and investment horizon.