Blame it on falling interest rates! Their barb against lower rated bonds in the past notwithstanding, fund managers have stepped up allocation to this segment in order to protect returns on their portfolio.
With sparkling returns on the back of the bull-run expected to sober down, debt funds now aim to increase their income stream with higher investments to below AAA debt instruments, which offer higher returns for their inferior credit quality and hence, higher risks.
Top rated corporate debt and government bonds offer maximum capital appreciation when interest rates go down but returns take a dip as yields stabilise at lower levels. Further, the coupon income from new instruments also goes down.
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"A lower rated debt instrument does not necessarily mean a poor quality paper. We have significantly increased our allocation to AA+ credits since these bonds have only marginally higher risk than AAA rated companies. For instance, we have chosen 5-year RPL (AA+) yielding 10.10% over 5-year Reliance Industries (AAA) yielding 9.6% since RPL is also a fundamentally strong company,'' says Vineet Udeshie at Alliance Capital Asset Management Company.
The rising exposure also means that fund managers are now attempting to strike a fine balance between interest rate and credit quality risks. So far, an overwhelming majority has stayed glued to triple A bonds with active portfolio management to guard against interest rate volatility.
This has also meant a sizeable allocation to sovereign securities, which are an ideal tool to manage portfolio maturity with their high liquidity. The average exposure to government bonds has been around 35% in recent times.
However, with a surging corpus and limited triple A corporate opportunities, funds have to scout for lower rated bonds since they cannot stretch beyond a point with their investments in government bonds.