Fund Call . HDFC Short Term Debt Fund: To tide over market volatility

Even as the yield on 10-year government securities has fallen sharply over the past year and investors in long-duration funds have gained handsomely, it may be a good idea to be cautious hereon. Over the past week, bond markets have been very volatile. While the week started with a sharp rally in bond prices, it ended with a significant rise in bond yields.

Hence, investors with a relatively low appetite for risk can opt for short-duration debt funds, to lower volatility in returns.

HDFC Short Term Debt Fund has been a top performer within the category of short-duration debt schemes. It has outperformed the category by 150-200 bps across three-, five- and seven-year time-frames.

The fund invests in debt instruments such that the Macaulay Duration of the portfolio is between one and three years. This minimises the interest-rate risk as short-duration bonds are less sensitive to interest-rate movements. HDFC Short Term Fund’s average maturity has been 1.5-3 years over the past two years. The fund focusses on interest accrual strategy (essentially interest income) to generate returns, and invests in relatively high-rated debt papers (78-88 per cent invested in AAA rated and equivalent bonds over the past year). Investors with a time horizon of one to two years can invest in the fund.

Moving parts

While 2019 was a relatively good year for bond investors, it was not devoid of volatility. The increase in CPI inflation and growing concerns over slippage in the fiscal deficit in the latter part of the year kept bond markets on tenterhooks. These concerns had also spilled over into 2020.

But since the beginning of this year, 10-year bond yields have been gradually declining, with the fall widening after the RBI announced Long-term Repo Operations (LTROs) in its February policy. Over the past week, multiple events have shaken the bond market. In the beginning of the week, both global and Indian bond markets saw a sharp rally in prices (yields plunging) as the impact of COVID-19 on growth appeared to exacerbate, fuelling expectations of continued easing of monetary policies across the globe.

However Christine Lagarde, president of the European Central Bank, not delivering on expectations of a rate cut, rattled investors. This also indicates the limited firepower with central banks globally on the monetary policy front to revive growth.

In India, too, bond markets have already factored in a 50 bps rate cut, and with the fiscal stimulus (implying oversupply of bonds) to come under focus, bond yields could witness upward pressure in the month ahead.

Hence, conservative investors should invest a chunk of their debt fund investments in short-term funds that carry less volatility in returns.

Fund performance

HDFC Short Term Fund has managed to beat its category across time periods and delivered steady returns across market phases. For instance, in the upbeat 2014 and 2016 market, while the scheme delivered 9-10 per cent returns, in the lacklustre 2015, 2017 and 2018 phases, too, it delivered tidy 6.5-8.7 per cent returns.

Aside from mitigating interest-rate risk, the scheme has also fairly managed to keep credit risk under check, investing in high-quality debt instruments. However, the fund’s investment in bonds issued by one of IL&FS’ special-purpose vehicles (SPVs), Hazaribagh Ranchi Expressway Ltd (HREL), ran into trouble last year.

Three SPVs of IL&FS had come under focus after one of them, Jharkhand Road Projects Implementation Company Ltd (JRPICL), was downgraded by CRISIL to ‘D’, after it defaulted on its payment in January 2019.

The reason for the default was the management’s decision to withhold payment of dues, citing the National Company Law Appellate Tribunal’s (NCLAT) stay order issued on October 15, 2018, that had imposed a moratorium on, among others, financial facilities or obligations claimed by IL&FS and its group companies.

Hence, schemes such as HDFC Short Term Fund having exposure to other SPVs such as HREL, also marked down the value of such underlying bonds in January 2019. In April 2019, as CARE Ratings downgraded HREL to ‘D’, the fund once again marked down the value of such bonds.

However, this has not impacted the fund’s performance significantly. One, to start with, the scheme had only about 0.5 per cent (of assets) or ₹49 crore (market value) of investments in HREL before the mark-down in December 2018, (which was rated AAA then).

Currently, (as of February 2020) after the mark-downs, the fund has an exposure of only 0.1 per cent of its assets to HREL.

Also, annuities of SPVs flow into trustee-controlled escrow accounts, and are normally sheltered from stress at the sponsor/parent level. In this case, the problem has arisen owing to IL&FS group’s stance in the NCLAT order (February 2019) that entities in ‘Amber’ would make payments to only the operational creditors for being a ‘going concern’ (according to CARE Ratings rationale).

However, if clarity emerges, the fund could recover part or whole of its dues.

Hence, this is not too much of a concern for investors in the fund. As of February, the fund has 75.9 per cent exposure to AAA rated and equivalent bonds, and 3.8 per cent to sovereign bonds. The fund has some exposure to AT-1 bonds issued by SBI.

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