Why short-duration funds from IDFC MF and Kotak MF are safe picks

Firmly focussed on growth, the RBI has continued to keep its policy stance accommodative. It has also kept the repo rate unchanged at 4 per cent since May 2020. While the central bank has been taking steps to normalise liquidity, a rate hike is expected only in 2022.

Given the uncertainty over the future course of interest rates, investors with a moderate risk appetite and with horizon of up to 3 years can go for short-duration debt funds. Here, choose from those with a high credit quality portfolio —AAA-rated and sovereign debt papers — for utmost safety. IDFC Bond Fund - Short Term Plan (IDFC STF) and Kotak Bond Short Term Fund (Kotak STF) are two such schemes. They can form part of your core debt portfolio.

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. Such funds derive their returns largely from the interest received on bonds/debt papers held (interest accrual). These funds are better placed than medium and longer-duration funds to benefit from any future rate hikes.

Once interest rates start picking up, short-duration funds can start investing in debt papers offering a higher yield as the older debt papers mature. These funds are also relatively less prone to interest rate risk — by way of fall in bond prices (capital loss) in a rising interest rate situation — compared to other longer-duration categories.

Performance

Both the IDFC STF and the Kotak STF have fared better than the short-duration fund category across different investment horizons based on a rolling returns (CAGR) analysis. Only funds in existence for at least five years and minimum assets under management of ₹300 crore have been considered. Over the last seven years, both the funds have generated an average 1-year return of 7.9 per cent versus 7.6 per cent for the category. The 3-year and 5-year average returns have been 7.6 per cent and 7.9 per cent for the funds compared to 7.2 per cent and 7.4 per cent respectively for the category (all returns are CAGR). Over the last seven years, the standard deviation (SD) for the IDFC STF and the Kotak STF has been 0.49 per cent and 0.51 per cent. The SD for peer funds ranges from 0.37 to 1.74 per cent. Higher the SD, the greater the return volatility.

While there are other funds in the category offering higher returns, IDFC and Kotak funds stand out for their consistently high credit quality portfolios — largely comprising the highest-rated sovereign and AAA debt papers. This offers the highest degree of safety.

Other details

The highest-rated debt instruments accounted for 94 per cent and 95 per cent respectively of the portfolios of the IDFC STF and the Kotak STF as of August 2021. This has been true in the past too. The two funds have consistently held over 90 per cent of their assets in such debt papers since September and March 2019, respectively.

The IDFC STF invests in debt instruments such that the average maturity of the portfolio is around 2 years (2.1 years currently). The Kotak STF, on the other hand invests in debt instruments of different maturities to diversify risk. The fund has accordingly had a wider-ranged average maturity of 1.4 to 3.9 years over the past five years (3.5 years currently). A detailed break-up shows that IDFC STF held 37 per cent of its net assets in debts papers maturing in up to a year, 25 per cent in 1-3 years and another 32 per cent beyond 3 years as of August 2021. Kotak STF held 16 per cent, 26 per cent and 51 per cent in the respective segments.

Since April 2021, both funds have been raising their holdings of government dated securities (g-sec), likely to take advantage of relatively higher yields in the five-year g-sec segment. As of August 2021, IDFC STF and Kotak STF held 31 per cent and 42 per cent respectively in such debt securities.

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