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Tuesday, December 12, 2017

Go Slow on Duration Funds





END OF Interest Rate Down CYCLE. We expect only one more rate cut, advise looking at accrual funds

After earning double digit returns from fixed income funds over a three year period, investors may need to brace for lower returns in the coming years. Wealth managers and analysts are advising fixed income investors to reduce the proportion of duration funds from their portfolio in favour of accrual funds after the Reserve Bank of India (RBI), in its policy review meeting on Wednesday , signalled it may not be in a hurry to cut interest rates.

We are at the fag-end of the rate cut cycle and there could just be one more rate cut

Investors to switch from gilt funds -- a product that invests in government securities -which have been top performers in the fixed income category in the last three years, to short-term accrual funds such as credit opportunity and corporate bond funds, where the focus is on earning interest income and rate-related risks. We recommends Birla Short Term Opportunities Fund and DSP Black Rock Income Opportunities Fund to fixed income investors with a 1-2 year time frame.

Investors should position their portfolios towards accrual strategies as no significant rate cuts are expected from here on.

The RBI, while cutting the repo rate by 25 basis points on Wednesday , maintained its neutral rating.

The Reserve Bank has opted to cut rates, but has maintained a neutral stance of policy ­ preferring to wait for further data to decide if rates should be further reduced

We recommends investors to raise the proportion of accrual funds in their portfolio to 66% from the earlier 50%, and reduce the proportion of dynamic bond from 34% to 25%. We recommends Birla Medium Term Fund and in the dynamic fund cate gory recommends TATA Dynamic Bond Fund.

Accrual funds focus on earning interest income from the coupon offered by bonds they own.

Duration funds look at earning income through both capital appreciation when interest rates decline. Though they can earn some returns from capital gains, it is typically small in proportion to their total returns.

In the last three years, investors have ear ned 10.57% from the Dynamic Bond category, 10.27% from credit opportunities and 11.92% from long term gilt category

We advise investors to lower their returns expectation to 7-8.5% as capital appreciation will be lower and investors can now earn returns only from interest accrued on bonds.





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