Birla Sun Life Medium Term Plan (BSL MTP) has been one of the top performing income funds in the last three years. The fund returned 11.1 per cent and 8.2 per cent (annualised) over the last one- and three-year periods.

It also outperformed its benchmark, CRISIL Short-term Bond Fund Index, on a rolling-return basis 100 per cent of the time since it was launched. But investors can avoid further exposure to the fund as there have been some changes in its strategy as well as asset size.

The fund recently revised its exit load and also changed its strategy to take exposure to slightly risky debt instruments. The fund’s risk profile now stands enhanced and is therefore not meant for conservative investors.

The fund now carries an exit load for withdrawals made within two years of investments compared with the three-month period that prevailed till April 2012. The fund will levy 2.5 per cent if investors sell units within six months of buying. This load gradually reduces to zero if investments are sold after two years.

With a longer time frame now available, the fund seeks to increase exposures in instruments outside of the highest investment grade.

But the exit load, coupled with the changed strategy, has led to an exodus of institutional investors from the fund, leading to average assets under management falling to Rs 76 crore in the June 2012 quarter as against Rs 568 crore in the March quarter.

Retail investors who can take slightly higher risks can stay with the fund but watch performance over the next six months to a year. Further exposure can be avoided until the fund replicates historical performance over the next one year.

Strategy

BSL MTP will now invest a good proportion of its portfolio in instruments outside the top investment grade category. That means it can take exposure to other than AAA-rated instruments to improve the returns of the fund.

While liquidity risk (risk of not being able to trade in the secondary market) can arise from investing in such instruments, the exit load up to two years will provide some comfort to the fund (as it will lower redemption pressure) and allow it to adopt a buy-and-hold strategy. Holding an instrument to maturity will reduce interest rate risk.

The fund manager also intends to reduce the interest rate risk by limiting its universe to investments with two-year tenure or less. Longer tenor instruments tend to suffer from higher price volatility even if interest rate moves are marginal.

Why hold

There has been a steep fall in short-term interest rates (less than a year) due to improved liquidity conditions, thanks to measures taken by the RBI thus far in 2012. Three-month investment-grade commercial paper rates declined from 11.8 per cent in March 2012 to 9 per cent currently. Three-month certificate of deposits, which are less risky and are the preferred choice of investment by short-term funds, currently carry an even lower rate.

After adjusting for exit load, the returns one would get from these instruments may not be attractive adjusted for inflation. Even a AAA-rated instrument with two-year maturity is currently trading at a yield of 9.5 per cent. That means that the universe of attractive investment options with short- to medium-term maturity and with highest credit rating has now become limited.

This may require funds to scout outside of this boundary to generate inflation-beating returns. This is perhaps what BSL MTP has sought to do. BSL MTP can invest in AA+ and AA instruments. Non-convertible debentures with AA rating continue to enjoy double-digit yields. If held to maturity, these instruments can provide high returns. That said, the credit risk may, however, stand enhanced compared with AAA-rated instruments as lower rated instruments have the risk of being downgraded. If they do, their prices will take a hit.

This is where the fund manager’s call on balancing risk and return may become critical.

During the last four months (since the change in exit load), the fund returned 4.5 per cent, higher than the category average of 3.57 per cent, providing some confidence in the changed strategy. It may yet be early times to judge performance.

Portfolio

As of July 2012, around 60 per cent of the portfolio was in corporate debt instruments that were not AAA-rated. A little over 20 per cent of the total portfolio has lower rating than AA. Short-term certificate of deposits and commercial paper accounted for 30 per cent of the overall portfolio.

The NAV of the fund is Rs 12.995.

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