In line with market expectations, the RBI kept the policy repo rate unchanged at 4 per cent in its latest monetary policy review. The central bank also decided to continue with its accommodative stance. While the possibility of near-term rate hikes appears low, given the concern over inflation, these may not be completely ruled out.
For now, it’s wait-and- watch. Given the current historically low rates, those with a moderate risk appetite and a 1-3-year investment horizon, can consider investing in short-duration funds.
Short duration funds invest in debt and money market instruments such as corporate bonds, debentures, certificates of deposits (CDs), treasury bills (T-Bills) and government bonds such that the Macaulay duration of the portfolio is 1-3 years.
Interest and credit risk
Returns from a debt fund depend on the interest received on bonds /debt papers held (interest accrual) and the appreciation or depreciation in these bond prices. Short- duration funds derive their returns largely from interest accruals and to a smaller extent from bond price changes.
Investors in short-duration funds stand to gain once the rate cycle starts turning up as these funds can then invest at higher rates. At the same time, compared with medium- and longer-duration funds, these schemes carry lower interest-rate risk. That is, when interest rates rise, short-duration funds which hold relatively lower maturity debt papers will be impacted to a smaller extent by a depreciation in bond prices (capital loss).
But short-duration funds may still be exposed to credit risk. Investors who want to play it safe must stick to high- credit-quality funds.
Over the last seven-year period until December ’20, the short- duration fund category has, on average, delivered a one-year rolling return of 7.9 per cent. On a three- and five-year rolling return basis, the category has offered 7.5 per cent and 7.7 per cent, respectively. Only short- duration funds with assets under management of at least ₹ 500 crore have been considered here.
Fund performance
Within this category, investors can consider the IDFC Bond Fund - Short Term Plan (IDFC Bond Fund). The scheme has delivered one-, three- and five-year average rolling returns of 8.3 per cent, 7.7 per cent and 8.0 per cent, respectively in the past seven years. While the IDFC Bond Fund has outperformed the category average over different holding periods, it has not always offered the highest returns. The fund’s high-credit- quality portfolio is, however, a big positive.
With 96 per cent of its portfolio in AAA (and equivalent) and sovereign debt papers as of October 30, 2020, IDFC Bond Fund ranks high on credit quality and is a safe bet in this category.
In the past, too, the scheme has maintained high credit quality. It has consistently invested 95 per cent or more of its corpus in AAA and equivalent and sovereign debt papers since June 2017.
It had an average portfolio maturity of 1.9 years in October 2020 and has kept it at 1.8- 2.2 years for many years, ensuring interest rate risk is kept under check.
Since its inception 20 years ago and through changing interest-rate cycles, the fund has delivered three-year return of at least 5 per cent (CAGR) over 90 per cent of the time, and at least 7 per cent (CAGR), 68 per cent of the time. During this 20-year period, the scheme has generated a five-year return of at least 7 per cent, 80 per cent of the time.