Prefer short-duration bond funds to credit-risk funds for safer investment

However, SEBI does not specify the credit profile of the funds

In the past year, a series of defaults, downgrades and delayed payments have left debt fund investors scarred. But debt funds do provide some amount of stability to a portfolio. And bonds funds investing in private sector corporate bonds could offer good risk-reward to investors who are keen to take some measured exposure.
 
But you should have a clear strategy. Short-duration funds could be a good investment bet at this point. Simply put, here fund managers invest in bonds that mature in one to three years.  In these schemes, the impact of interest rates movement is not much. In the bond market, if interest rates move up, bond prices fall, and so does the scheme net asset value (NAV) and vice-versa. Short-term bond funds look good given the ongoing attractive yields. “The rally in G-Secs has happened; hence duration is not advisable for fresh entrants. Short-duration funds offer better defence against interest-rate volatility than long-term funds,” says Joydeep Sen, founder, Wiseinvestor.in.
 
Agrees S Sridharan, head, financial planning, Wealth Ladder Investment Advisors: “We don’t recommend long-duration funds at this point. Short-maturity papers are available at an attractive yield, and also the risk-reward return doesn’t work in favour of long-term debt funds,” he said.
 
However, there is a minor hiccup here. Market regulator, the Securities and Exchange Board of India (SEBI), does not specify the credit profile of the funds. So, you will come across schemes that offer varying risk-reward options. Some stick to only high-rated bond and some of them go for low-rated bonds to give a boost to the portfolio. That may make the decision a bit difficult for investors and they may have to rely on expert advice.
 
Even the risk-averse can take this route through corporate bond funds. These funds invest at least 80 per cent of the money in AAA-rated bonds. Though the investments are made in private sector entities, a significant allocation to AAA-rated bonds offers some comfort for investors. “At this juncture, investors are extremely cautious. If one wants to invest in safe debt funds, they need to look at high credit rating, low average maturity and low-interest rate sensitivity. Considering these, good quality AAA-rated corporate bond funds could be the better alternative to credit-risk funds. If one has a time horizon of two years or more, it is ideal to invest in corporate bond funds. The yield-to-maturityy on most of the funds in this category is around 8 per cent,” says Sridharan.
 
Another good bet for the risk-averse investor could be the banking and public sector unit bond funds. These funds invest in bonds issued by banks, certificate of deposits of banks and bonds issued by public sector undertakings. Some of the portfolios do hold some long-term bonds, which reward investors in a falling interest rate regime.

Strategies 

• Invest for a minimum of three years; tax benefit 20 per cent after indexation 
• Look at corporate bond funds, as 80 per cent of corpus is invested in AAA-rated papers 
• Banking and PSU bond funds are another option

 
The risk-taker can go for credit-risk funds but given the current situation, it would be better to avoid them or invest in them in small quantities. Currently, the credit spread is very low, and quality papers are available at a better rate. Secondly, most of the mutual funds barring IDFC have exposure in the range of 10 per cent - 40 per cent in less than AA papers. This carries high risk at this juncture. The credit risk category has witnessed a whopping 18 per cent fall in their AUM between September and June,” Sridharan points out
 
And last but not the least, invest for a minimum three-year time frame. These funds are expected to deliver over the three-to four-year time frame, as that is the typical average maturity of most of these schemes. It is better to match your holding period with the average maturity profile of the portfolio to ensure that there are no negative surprises due to changes in interest rates. Another advantage is the tax benefit that comes with holding for three years. Keeping it for this period entitles the investor to long-term capital gains tax.
 
Gains on funds held for at least three years are taxed at the rate of 20 per cent after indexation.