Banking and PSU Debt Funds: A good bet in volatile times

By staying the course on the fiscal front, the Finance Minister brought cheer to bond markets. But this was short-lived, as bond markets were jolted by the RBI’s shift in policy stance recently.

Over the past week, yield on the 10-year G-Sec has gone up by nearly 40 basis points to 6.8 per cent.

Given near-zero chances of further rate cuts by the RBI and possibility of US hiking rates aggressively, domestic bond yields can harden further. The ample liquidity in the system, may also lead to the RBI lowering the pace of OMOs ( i.e. buying of government bonds) this year, adding pressure (on the upside) on bond yields.

This implies that the upside for investors in long-term government securities will be capped from here on.

At this juncture, for investors looking for lower volatility and stability in returns, short-term debt funds may just be what the doctor ordered. There is also some possibility of upside on the shorter end of the yield curve, given the surplus liquidity in the system.

Within the short-term debt funds category, Banking and PSU Debt Funds offer stable returns, a good play on rate movement on the shorter end of the yield curve and low credit risk.

These funds seek to minimise risk by investing in good-quality debt instruments, mainly issued by banks and public sector undertakings. With a duration between one and three years, these funds generate accrual income and capital appreciation by deftly juggling various debt instruments.

The portfolio of these funds mainly consists of certificate of deposits (CDs) issued by banks, commercial paper (CPs) and corporate bonds issued by high-rated public sector undertakings.

To ride on rate movements (duration), these funds also intermittently switch in and out of G-Secs, within their relatively shorter duration mandate.

The source of divergence in performance (albeit marginal) for these funds mainly stems from the duration calls they take as also the proportion of holdings across various debt instruments.

There are nine funds within this category that carry the ‘Banking and PSU Debt Fund’ tag currently. As most of these funds were launched only recently, they do not have a performance track record beyond three years.

On the top of the pecking order, is ICICI Pru Banking & PSU Debt Fund, which has consistently delivered category beating returns. This fund also has a longer track record as it was launched in January 2010.

Over one-, three- and five-year periods, this fund has delivered 13.5 per cent, 10.7 per cent and 9.9 per cent respectively. UTI Banking & PSU Debt Fund and HDFC Banking & PSU Debt Fund are a close second, based on one and two-year performances, returning 11.5 per cent and 10.2-10.5 per cent, respectively.

DSP BR, Franklin India, Sundaram, DHFL and Axis are some of the other fund houses managing such funds, delivering relatively lower returns.

The portfolio of some of the top performing fundsreflect the mandate of these funds. ICICI Banking & PSU Debt Fund, for instance, has maintained an average duration of 1-3 years over the past two to three years.

It has kept nearly half of its portfolio in AAA rated corporate bonds over the past two years, and another one-fourth of its assets in G-Secs. CDs have been less than a tenth of its portfolio.

UTI, on an average, has maintained about a fifth each in CDs and G-Secs over the last one year. HDFC has kept about over two-thirds of its holdings in AAA rated bonds.

The duration for ICICI Banking & PSU Debt Fund has been higher than other funds at about 3.4 years over the past year. The longer track record of the fund’s performance makes it a good bet for debt investors looking for stable returns with low interest rate risk or credit risk.

Of the other funds, UTI and HDFC Banking & PSU Debt Funds also offer the comfort of a low-risk credit portfolio as well as good track record (shorter, though) of returns.

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