Debt funds have had a stupendous year in 2016, thanks to the sharp fall in the yields of government bonds. From the 7.7 per cent levels in the beginning of the 2016, yields have fallen by a whole 125-odd basis points to 6.4 per cent levels, even as the RBI lowered its key policy repo rate by just 50 basis points.

A couple of events led to the accelerated fall in G-Sec yields. The RBI’s desire to move to a neutral liquidity regime, since the April policy, was followed by a series of open market operations — buying of government bonds. This sucked out supply of government bonds, led to rise in prices and fall in yields. The next leg of the bond rally began post the Centre’s demonetisation move, which saw banks flush with liquidity, lapping up government bonds.

From hereon, however, the rally could be limited. For one, we are nearing the fag end of the rate-easing cycle, with headroom for another 25-50 basis points rate cut by the RBI. Two, if the US Fed turns aggressive with its rate hikes in 2017, the RBI may find it difficult to cut rates. Three, in the ensuing months, if some amount of liquidity remains in the system, after currency flow normalises (after lifting of withdrawal caps), then the RBI may not conduct OMOs at the same pace as last year, capping the fall in bond yields.

Hence, instead of taking an interest rate risk by investing in long-term gilt funds, investors can consider short-term income funds that carry less volatility in returns.

Birla Sun Life Short-Term Opportunities Fund, which runs an average duration of 1-3.5 years, fits the bill. While the lower duration mitigates the rate risk, following an accrual strategy helps rake in returns through accrual of interest on the bonds in the portfolio as well. While the fund invests in low-rated corporate bonds offering higher yields, about half of its portfolio has been in safe government bonds and AAA rated debt instruments over the past two years. This lowers the credit risk to some extent.

Consistent performance

The fund has consistently delivered above category returns across time periods. Its annual compounded average return of 10.4 per cent over the past five years is over one percentage point higher than the category average. The fund has also delivered consistent returns across all rate cycles. It has performed in both up and down rate cycles – March 2010 to October 2011 (up) and April 2012 to May 2013 (down) – delivering close to 13 per cent returns. Even in the lacklustre 2015 market, the fund gave a healthy 8.5 per cent return. Over the last one year, the fund has delivered about 11.3 per cent return, around 1.4 percentage points more than its category average.

Birla Sun Life Short-Term Opportunities Fund has currently (as of November 2016) invested about 62 per cent of its portfolio in ‘AAA’-rated bonds and G-Secs put together. ‘AA’-rated bonds form about 31 per cent. Top ‘AAA’-rated bond holdings include Reliance Utilities & Power, Indiabulls Housing Finance and Dewan Housing Finance Corporation. The fund’s exposure to ‘AA’-rated debt paper of Cholamandalam Investment & Finance is slightly higher at 8.9 per cent. Currently, the yield-to-maturity of the fund is around 7.3 per cent and the duration is 3.8 years.

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