In the current context you would be hearing from your adviser to shift to short term bond funds, which have a portfolio maturity of two to four years, from longer maturity bond funds. The rationale is that the RBI Monetary Policy Committee is unlikely to reduce interest rates further, even though inflation is lower than expected.
If interest rates remain stuck in a range, shorter maturity bond funds would be more stable in performance and will do better than long bond funds. When you are doing a shift from a 10-year portfolio maturity fund to a 2-year maturity one, or even if you are holding on to a long maturity fund, you are consciously aware of the strategy of the fund. The context here is, the cases where you may be unknowingly holding on to a long portfolio maturity fund, which may be volatile if and when interest rates move up.
Where it tends to get ignored is in hybrid funds. In a focused long maturity or short maturity fund, you tend to take note of it. In a hybrid fund, you take note of the overall strategy of the fund and portfolio allocation to debt or equity as per mandate of the fund and fund manager’s view on market movements. You tend to ignore the portfolio maturity of the bond component of the hybrid funds’ portfolio. Let us look at a few examples, which will give you clarity. MIP funds have 75-85% allocation to debt and 15-25% allocation to equity.
They generally declare dividend every month, hence the name ‘monthly income plan’ (MIP). These funds give a small exposure to equity to otherwise fixed income oriented investors. The debt component is generally kept conservative, like a short term bond fund, so as not to take any undue volatility risk in the debt component.
Normally, a range of two to five years of maturity is similar to the strategy of a short term bond fund. As per latest data, in a universe of 37 MIP funds, 18 funds have portfolio maturity less than five years but seven funds have their debt component maturity more than eight years. This kind of portfolio maturity, i.e., more than eight years is comparable to a long bond fund or dynamic bond fund.
There is nothing wrong in having a long portfolio maturity and the fund manager may have a positive view on the market; i.e., s/he may expect interest rates to come down. The point is, if you are doing a shift from long bond to short bond funds, you should be aware what kind of portfolio maturity you are exposed to in your MIP fund. It should not get ignored just because it is a hybrid fund.
You might also want to see this:
Another category of hybrid funds is equity savings funds. In these funds, up to 35% is in debt, 30-40% is invested in equity and another 30-40% is in arbitrage; i.e., buy position in equity cash market and sell position in the same stock in equity futures market. In this category, the market risk is taken in the open or unhedged equity component and the debt component maturity is mostly in the range of one to five years.
However, in a universe of 10 equity savings funds there is one fund with a portfolio maturity of more than 12 years. There is a category of funds called arbitrage, wherein 65% of the portfolio is in equity cash-futures arbitrage and 35% is in money market or debt instruments. There also you need to check on a similar logic.
The whole reason why you are reviewing your portfolio is to avoid undue volatility as interest rates are expected to be on a long pause now and may move up later as and when the situation warrants. If you are continuing in a long bond fund in which you had invested earlier, it’s a conscious decision. The same logic applies to your hybrid fund exposures as well.
The writer is managing partner, Sen & Apte Consulting Services LLP.