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Looking to park money for a very short period for slightly-better-than-bank-FD returns? Low-duration debt funds that carry relatively lower interest rate risk may fit the bill. While such funds can be exposed to credit risk — due to possible default by a company issuing bonds in which the fund invests — filtering funds that predominantly hold debt securities with the highest rating can lower this risk.
IDFC Low Duration Fund (erstwhile IDFC Ultra Short Term Fund) which holds a chunk (98 per cent) of its holdings in AAA rated bonds is a good option for conservative investors. The fund has delivered an annual return of 7.6 per cent since its launch in 2006. Over longer five to 10-year periods, the fund has delivered about 8 per cent returns. In good years, the scheme has also delivered upwards of 9 per cent returns. While these are not spectacular returns, considering that there have been long-duration debt funds that have delivered double-digit 16-18 per cent in favourable interest-rate environments, for investors looking at lower volatility in returns, low-duration bond funds are ideal.
Volatile market
While the RBI cut its key policy repo rate in its April policy and is expected to cut rates further, fiscal concerns and uncertain inflation trajectory is keeping bond markets on tenterhooks. Post the policy in the first week of April, yield on 10-year G-Secs has only been inching up, indicating the edginess in the market. For risk-averse investors, low to short-duration debt funds that can help tide over volatile markets are a better bet.
Low-duration bond funds invest in debt instruments such that the duration (Macaulay) of the portfolio is 6-12 months. This mitigates the rate risk and the volatility in bond prices. This is because short-duration bonds are less sensitive to rate movements. IDFC Low Duration has been a steady performer in this category, and investors looking to park surplus money for up to a year can consider the fund. Most banks currently offer 6.5-7 per cent. While there are a few banks that do offer better rates, remember that bank fixed deposits are locked in for a specific tenure, and premature withdrawal attracts penalty. Of course, mutual funds carry market risk; hence, invest in them only if you are willing to take such a risk.
Portfolio
One way to mitigate credit risk in bond funds is by checking the fund’s portfolio for risky investments. Recent events around debt funds’ investments in IL&FS or Essel bonds highlight the need to dig deeper into funds’ portfolio before investing. Going by the latest portfolio (as of March 2019), credit risk appears low in IDFC Low Duration, which predominantly invests in high-rated AAA and A1+ debt papers.
While the fund does have high exposure to certain bonds (9-10 per cent of assets), these are in quality names such as Reliance Industries (AAA rated corporate bond), Axis Bank (A1+ certificate of deposits) and HDFC (A1+ commercial paper). The fund’s average maturity is about 361 days, and the current yield to maturity (YTM) is 7.6 per cent.
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