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Bond fund investors could face some surprises in their returns if they are not careful with fund selection, say experts. Bond funds are starting to show a divergence in performance as interest rates are still choppy and fund managers are taking varying stance on the maturity of underlying debt portfolios. Depending on the call a fund manager takes, investors have to attune the portfolios accordingly or they could get hit.
In the past, interest rates had remained in a tight range but of late, rates have been bouncing quite sharply. The 10-year g-sec hit a low of 7.16 per cent and a high of 9.48 per cent in a span of five months. In such an environment, experts say, it is critical for an investor to look at the time horizon of a fund and the quality of its paper.
Says Dhawal Dalal, head (fixed income) at DSP BlackRock MF: “Interest rates this past quarter have been quite volatile. We believe that if you get the duration management right, there’s scope for incremental returns.”
Fund managers are following two different strategies for incremental gains in this highly volatile debt market. One is to manage the duration of bond funds actively, that is increase or reduce average maturity depending on where they see interest rates headed. The other is to look at marginally lower-rated paper, where the yields are higher and where the fund accrues the interest till maturity.
Debt funds can get hit if any of these calls go wrong. For instance, if the debt maturity profile is high and interest rates rise, investors could see negative returns on their funds. Similarly, if lower-rated papers default on their interest on principal payment, investors will again have to bear the brunt of the defaults.
In July, liquid funds had given negative returns on a daily basis for the first time in the last 10 years. Various debt fund categories had also given negative returns in the months of August and September. Bond fund managers say that the past few months have been a learning experience for retail investors who weren’t expecting such losses, but they are still not attuned to getting their investment horizon right.
Says Amit Tripathi, head (fixed income) at Reliance MF: “There are different maturity profiles and each caters to a different time horizon of investors. One will also have to match how long they plan to stay invested along with the duration of the fund as this is what retail investors tend to overlook.”
Retail investors have to increasingly know the horizon for which they want to invest, say experts. Investors entering the bond markets for three years should invest in funds that have an average maturity profile of their bond holdings of around three-to-four years. Experts say investors have to wait for the maturity profile of the bond fund to play out. A sudden spike in interest rates wouldn’t be too much of a worry if an investor holds out for around three years, as bond funds will recover during that time if there’s an interest spike.
