Bond funds: Fixed income investors’ favourite

Let’s explore what lies ahead and where to look. Basically, meant for conservative investors seeking stable income with a lower risk of capital loss, these funds provide an option for investors to own a diversified portfolio comprising corporate and government bonds, which otherwise would be difficult. It is also suited for those wanting to diversify against the risk of equity ownership. And if interest rates fall, these funds benefit from capital gain in bond values.

Though a portfolio comprising just bonds is not susceptible to big gyrations, as compared to stocks and stock funds, these funds are not risk-free either. They are prone to interest rate and credit rate risks attached to individual bonds and the risk of reduced liquidity in a bond. The loss during May this year is indicative of the same.

Thus medium-term debt funds can no longer be regarded as a safe bet. Taking this into account, bond fund families are also attaching premium on safety. Earlier rate cuts have led to astonishing evaporation of yield across the bond universe. The 5-year GoI security now yields 6.36% while corporate bond benchmark of similar duration yields 7.1%. This is in contrast to the 8.2% yield of corporate bonds three months back. Hence, fixed income investors have no choice but reconcile with lower returns.

After scary losses in the volatile month of May, funds reduced their rate sensitivity by paring their gilt exposure —from a high of nearly 40 per cent to below 30 per cent. But they are beginning to get bold with gilts again, pointing to the emerging consensus of rate softening. On credit quality, funds are reasonably risk averse unwilling to chances emphasising top-rated bonds.

Gone are the glory days for these funds, from now on they are likely to post an average return and will be volatile too. But they still continue to be an attractive choice for medium-term fixed income investor.

The basic fund attributes like, high liquidity and tax efficiency for over 1-year investments are another plus. I have classified my picks among the medium-term debt funds into two category: steady ones and timely-movers.

Stable bond funds have a large asset base. They don’t make aggressive duration bets and, indeed, provide returns with greater stability. But don’t expect more, as they prove to be consistently anchored around the average. These include:

Birla Income Plus: Launched in 1995, this 4-star’s trailing 1-, 3- and 5-year returns are above category average. The fund has achieved this by aggressively managing interest rate bets and astute selection of high-quality bonds with wide diversification.

K-Bond: A high-quality focus, a well-timed investment into lower-rated issues plus dexterous handling of interest rate risk has been a win-win strategy for this fund, which was launched in 1999. It has given a YTD return of 9.72%.

Prudential ICICI Income Plan: Launched in June of ’98, Prudential ICICI Income’s strategy of investing in high quality debt and maintaining low volatility has worked all through, to provide a return which is a tad above the category average. The timely-movers make duration bets to enhance returns. For a bond fund, if you thought they only go up, these could be a bit jerky. But they hold promise as they can deliver that little extra. My choices include:

JM Income Fund (G): This fund—which was launched in 1994—has always been a top scorer, with a 3-year return of 14.8%. The reason: skillful handling of portfolio and aggressive time management.

Templeton India Income Builder Account: Since its launch in 1997, this 4-star fund has outperformed its average peer and has stayed in the top quartile of the category. Its YTD return is 10.65%.

Alliance Income: Launched in 1997, this fund has had a steady innings, consistently clocking good returns. The fund follows a conservative approach and has avoided large interest rate bets. Its YTD return stands at 10.68%.

The author is the chief executive of ValueResearch, which tracks mutual funds. He can be reached at dhiren@valueresearchindia.com