Interest rates have been moving down for over a year now. Debt funds, gaining on the back of bond rallies, have been making hay. The RBI’s 175 basis point cut in its key repo rate since January 2015 and its move (since April policy) to increase open market operations — buying of government bonds — has led to bond prices moving up and yields lower. From 7.7 per cent levels in the beginning of this year, yield on the 10-year G-Sec has fallen to 6.4 per cent levels. From hereon, while the quantum of fall in G-Secs yields may moderate and rate actions in the US can play a dampener, interest rates on the shorter end of the yield curve can move lower at a faster pace.

The Centre’s recent demonetisation scheme has given a boost to bank deposits. With no meaningful recovery in bank credit growth expected, banks will likely deploy these funds in government securities and high rated bonds which will lead to lower yields, particularly on the shorter end of the curve. Banks being flush with liquidity will also lead to a fall in deposit rates.

Hence investors with an investment horizon of 9-12 months can consider parking some of their funds in short-term debt funds which are likely to fetch higher returns.

Birla Sun life Short Term Fund has had a good track record of delivering returns across time periods and rate cycles. Over a three and five-year period, the fund has delivered an annual return of 10.4 per cent and 10 per cent, respectively, outperforming its category by 60-70 basis points.

High rated bonds

While the fund’s interest rate risk is mitigated by its lower duration — between one and three years — its credit risk is also low. The fund predominantly invests in government bonds and higher rated securities, with these bonds constituting 65-75 per cent of its portfolio on an average over the last two to three years. Deft juggling of bonds and money market instruments of short to medium term maturity has helped the fund deliver good returns across cycles. Between March 2010 and October 2011, for instance, when the RBI raised its policy repo rate by a sharp 375 basis points, the fund invested mostly in certificate of deposits. The average duration was about less than one to one year during this period and the fund gained around 11 per cent.

During the 2014 bond rally, the fund increased its holdings in high rated corporate debentures substantially and upped its duration to about 1.7-2 years and delivered about 11 per cent return. Even in the nothing-to-write-home-about bond market of 2015, the fund delivered around 9 per cent return.

Current portfolio

Over the last six months, the fund has increased its duration to over two years. The fund, while trimming its exposure to money market instruments such as certificate of deposits and commercial paper, has been incrementally adding to its holdings in corporate debentures and government bonds.

It currently holds 51.8 per cent in AAA rated bonds, 34.3 per cent in government securities and about 10.8 per cent in AA rated bonds. Any fall in short-term rates should benefit the fund. Duration is about 2.2 years and yield to maturity is 7.4 per cent.

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