Spotlight. 5 low-duration funds to ride out rate volatility

A weakening rupee and the rise in crude prices have resulted in the yield on 10-year government bonds moving up sharply in recent times. While the RBI did two back-to-back rate hikes in the June and August policies, the possibility of further hikes in the next policy, in October, or even earlier, has increased. Currently at 8.1 per cent, the yield on 10-year G-Sec can move up to 8.2-8.3 per cent in the coming months — a not-so-comforting scenario for bond investors. Remember, bond prices and interest rates are inversely related to each other — when interest rates move up, bond prices fall, and vice-versa.

Hence, if you are a conservative investor with a short-term horizon of up to a year, you can opt for low-duration funds, which, according to SEBI’s new categorisation norms, have to invest in debt and money market instruments, such that the Macaulay duration of the portfolio is 6-12 months.

Macaulay duration is a measure of how long it takes for the price of a bond to be repaid by the cash flows from it. As a bond with a longer maturity period is more sensitive to changes in interest rates than one with a short duration, investors can opt for funds with shorter duration to ride out the ongoing volatility in interest rates.

SBI Magnum Low Duration Fund, (previously known as SBI Ultra Short Term Debt Fund), Tata Treasury Advantage Fund ( earlier known as Tata Ultra Short Term Fund), UTI Treasury Advantage Fund, AXIS Treasury Advantage Fund and Franklin India Low Duration Fund are five funds that have delivered steady returns across time periods and rate cycles.

Over a three-to-five-year period, these funds have delivered 7-9 per cent return annually. Post SEBI’s re-jig in scheme categorisation, these funds have not seen much change, as their modified duration (a version of the Macaulay duration that takes interest rates changes into account) has been 6-8 months on an average, barring Franklin Low Duration that ran a higher duration of 10-18 months.

Investors looking for alternatives to bank savings deposit or very short-term deposits can push up returns by investing some of their surplus in these low-duration funds.

How returns compare

Since low-duration funds carry a Macaulay duration of 6-12 months, the rate risk is lower. However, since they are market-linked, they carry higher risk than bank deposits. But for a slightly higher risk, low-duration funds can offer better returns.

Top-performing low-duration funds have delivered 7-9 per cent returns annually in the past seven years.

There is, of course, the tax aspect to consider. For investors looking at debt funds for a period of less than three years, their returns will be taxed at the income-tax slab rates. Savings accounts score better on the tax front — interest of up to ₹10,000 is exempt under Section 80TTA of the Income Tax Act.

But even assuming a 7 per cent return on low-duration funds, post-tax returns work out to 6.3 per cent, 5.6 per cent and 4.8 per cent, respectively, for individuals in the 10, 20 and 30 per cent tax brackets.

This is higher than the 4 per cent that most banks offer on savings deposits; only a handful offer 6-7 per cent for high-value deposits. Also, tax exemption on interest is only up to ₹10,000. Hence, if you are looking at a large surplus, low-duration funds score on returns.

SBI Magnum Low Duration Fund, Tata Treasury Advantage Fund, UTI Treasury Advantage Fund, AXIS Treasury Advantage Fund and Franklin India Low Duration Fund have been steady performers within the category, managing to deliver 7-9 per cent annual returns over the past 5-7 years.

Performance and portfolio

While these funds, given their lower duration, may not be able to cash in on bond rallies as longer-duration funds do, their steady performance across rate cycles lends comfort to conservative investors.

For instance, in the bond rallies of 2014 and 2016, while gilt funds that invest in long-duration government bonds raked in double-digit returns, these funds delivered lower 8-9 per cent returns. But these funds managed to deliver about 8.5 per cent and to-near 7 per cent returns in the lacklustre 2015 and 2017 years, respectively, when gilt funds delivered 6 per cent and 2 per cent returns, correspondingly.

Hence, with interest rates now hardening, these funds can help contain the downside better and deliver steady returns.

Most of these funds also carry a low credit risk with predominant investments in high-rated AAA debt papers.

Franklin Low Duration, however, has always had higher 60 per cent and above investments in low rated — below AA+ — bonds.

This pegs up the risk. Higher exposure to low-rated debt instruments has helped the fund deliver slightly higher returns than its peers. Hence, only investors with more risk appetite should consider this fund.

Savvy investors can opt for direct plans under these schemes, which come with lower expense ratios as they save on distribution charges. Returns are 20-30 basis points better in the direct plans than in the regular plans of these low-duration funds.

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