Franklin Corporate Bond Opportunity: Buy

Interest rates have come down sharply in the last one year with the yield on the 10-year government bond falling from 8.2 per cent last year to 7.6 per cent now.

But investors need not look to gilt funds alone to ride the resulting bond rally. Debt funds that invest in corporate bonds can also offer higher returns, but through a different route. These funds earn higher returns by investing non-AAA bonds. Aside from a downward rate cycle, such funds can also gain from a possible revival in the economy that can lead to rating upgrades. Franklin Corporate Bond Opportunity is one such fund that invests in bonds, taking on credit risk to earn higher interest. The fund has outperformed its category average over one and three-year periods.

Higher risk It is true that corporate bond funds — unlike gilt funds that invest only in government securities — carry the risk of loss of capital. This is because corporate bonds (borrowers) can default on their payment obligations. They can also be downgraded by rating agencies on several grounds, which can erode the bond’s value.

Recently, two JP Morgan debt funds that had invested in Amtek Auto’s bonds, suffered huge losses owing to rating downgrades. But what led to steep erosion in the funds’ NAV, was their large exposures to the Amtek Auto bonds. Hence as investors, it is essential that you pick funds that have a diversified portfolio and low concentration risk.

Franklin Corporate Bond Opportunity currently invests about 64 per cent in A rated bonds, 27 per cent in AA rated and a negligible portion in AAA rated bonds. While this pegs the fund’s risk higher, its diversified portfolio offers comfort.

As of October 2015, the fund has invested in bonds of close to 50 corporates, with highest exposure at 6.9 per cent to JSW Steel’s AA rated bonds. Compared to some of the similar funds in its category, Franklin Corporate Bond’s portfolio carries lower concentration risk. Birla Sun Life Medium Term Plan, for instance, has investments in about 20 corporates, with 9 per cent in AAA bonds, about 31 per cent of its assets in A and below rated bonds, and another 30 per cent in AA rated securities.

Consistent performer

Franklin Corporate Opportunity Fund has delivered 10.6 per cent annualised return since its inception in December 2011. In the 2014 rally, the fund clocked 12 per cent return.

Over a three-year period, the fund’s 10 per cent return places it in the top quartile of its category. It has delivered 9.6 per cent return in the last one year, much higher than the category average of 9.2 per cent. The yield to maturity (YTM) for the fund has been in the 10.7 to 12 per cent range. The current YTM of 10.8 per cent is among the highest within its category. The strategy of the fund is to keep the average maturity below three years, at 2.5-2.7 years. This mitigates the risk of interest rate movements.

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