[GTO]

Great discussion, guys! Moving all the debt fund posts to a new thread

[Sedate]

Originally Posted by SmartCat

Interest rate risk in debt funds is basically "volatility risk". ............

Can we also discuss about the liquidity risk, especially in the context of Franklin Templeton fiasco and closing down of multiple debt funds.

Also I have read somewhere about the hidden risks in PSU and Banking Debt funds. It was from an article in 2014 or 2018. Since they are the rage these days, cant find the specific article by googling - New results are masking old ones.

I think it was to do with AT1 bonds etc. , but not sure. Do you see any known risks from the Banking and PSU funds?

[carboy]

Originally Posted by Sedate

I think it was to do with AT1 bonds etc. , but not sure. Do you see any known risks from the Banking and PSU funds?

https://economictimes.indiatimes.com...w/58453550.cms

[ZenMaster]

The wealth manager in our bank recently advised my dad to switch from Debt funds to either a Balanced Asset Fund or a Multi Asset Fund since the returns on the Debt funds were abysmal.
His advice was that Balanced Asset Fund was a good balance on Risk vs reward if our aim was "investment" or wealth creation.
While he was pushing Multi asset fund, he himself advised against going for it especially for people nearing their retirement, since the risk was way higher even though the "potential" rewards could be good.
He also said to use FD only if we wanted to park our money since the current and future inflation rates could neutralise any gains made.

[SmartCat]

Originally Posted by Sedate

Can we also discuss about the liquidity risk, especially in the context of Franklin Templeton fiasco and closing down of multiple debt funds.

You had issues with liquidity in Templeton because there was a default. So Templeton like cases are default risk.

Liquidity risk is when many investors try to sell their debt mutual funds at around the same time. The fund manager will not be able to get the right price for the bonds, and the NAV will crash (like it happened in March 2020). There is nothing you can do here - your only option is to invest in "overnight funds" or "gilt funds". These funds do not have liquidity risk, because money rushes into these funds whenever there is a crisis.

How to reduce the effect of defaults on your debt fund NAV:

Let's look at our Aditya Birla corporate bond fund's portfolio aggregates data again:
https://www.valueresearchonline.com/...rate-bond-fund



Here, look at "number of securities" data. This fund is well diversified across 265 bonds from different companies. Next step is to look at portfolio of the debt fund and % assets column:



Note that the highest holding in this fund is L&T bond at 2.32% weightage (GOI bond is risk free, so ignore that). Even if a few companies go down, it is unlikely to significantly damage the NAV.

Now compare this portfolio with that of Franklin India Income Opportunities Fund:
https://www.valueresearchonline.com/...tunities-fund?





Note that this fund has just 41 securities. And worse, they have 50% of their assets in 5 companies. And unknown names like "coastal gujarat power" too. We can also look at credit ratings (AAA, AA etc) but they are unreliable. These rating companies slash ratings AFTER default!

I think it was to do with AT1 bonds etc. , but not sure. Do you see any known risks from the Banking and PSU funds?

AT1 bonds are "unsecured" bonds. So most likely that fund managers of credit risk fund category invest in such bonds. Out of Yes Bank's Rs. 60,000 cr AT1 bond offering, only Rs. 3,000 cr was picked up by mutual funds - mostly by credit risk funds. However, bonds (AT1 or otherwise) of PSU banks is considered as quasi-sovereign debt by mutual fund managers. They have faith that Govt will pitch in case of default. Just like how we think Fixed Deposits in PSU Banks is safe!

[Naetik30]

Originally Posted by SmartCat

This particular fund's yield to maturity is 4.54% and Avg maturity is 1.9 years. What this means is: If you invest in this fund today, you are likely to get 4.5% per annum over the next 2 years.

I have included the word "likely" because the above numbers might change if there are defaults or if fund manager drastically changes portfolio over the next 2 years. For eg: he might exit lower yielding bonds and add higher yielding bonds.

One question - does this mean, it is 4.54% per annum for 1.9 years (or) 4.54% for the 1.9 years? I think it is the later.

[SmartCat]

Originally Posted by Naetik30

One question - does this mean, it is 4.54% per annum for 1.9 years (or) 4.54% for the 1.9 years? I think it is the later.

- NAV of this fund will go up approximately 9% by the end of 2 years from today.
- Another example: if yield to maturity of an ultra short term fund is 3% and its average maturity is 0.5 yrs, it means the NAV of this fund will be up approximately 1.5% over the next 6 months.

Yield to maturity % is an annualized number, not absolute.

[Fx14]

Originally Posted by SmartCat

There is nothing you can do here - your only option is to invest in "overnight funds" or "gilt funds".

Any specific filters / red flags that you look for while deciding which Overnight funds to invest in?

Given the daily maturity profile, there are no portfolio details available for reference.

Also, observed (on Value research site ) that the funds reflecting higher past 1 year returns are those with smaller AUM.

[SmartCat]

Originally Posted by Fx14

Any specific filters / red flags that you look for while deciding which Overnight funds to invest in?

Pick an overnight fund with the lowest expense ratio from a reputed fund house.

Also, observed (on Value research site ) that the funds reflecting higher past 1 year returns are those with smaller AUM.

Probably because such funds have low expense ratio.

Given the daily maturity profile, there are no portfolio details available for reference.

Correct. Banks primarily dip into the overnight market to access funds for their daily cash management needs. Essentially, your money is being lent to banks for 1 day. Think of the investment in overnight funds as 1 day bank fixed deposit.

HDFC Overnight fund is the oldest such fund:
https://www.valueresearchonline.com/...overnight-fund



Yield to maturity of 3% means the current returns are around 0.008% per day. However, in the past, overnight funds have returned even 8% pa. This happens when there is lack of liquidity in the financial world.

[Vegitocat]

This is an awesome thread and answers a lot of questions I had about debt funds. But, I am not sure I understand the average maturity. For HDFC Corporate Bond Fund the average maturity is 4.80 years and YTM is 5.42%. The 3yr and 5yr historic returns are at 9.23% and 9.11%.

For someone who has invested 3 years ago, would the return be 9.23% as on today? How should the average maturity be read in this context?

Also if someone continues to hold the investment after 3 years what would the returns look like?

[SmartCat]

Originally Posted by Vegitocat

. But, I am not sure I understand the average maturity. How should the average maturity be read in this context?

Let's say you have:

- Rs. 1 Lakh invested in 1 year fixed deposit
- Rs. 1 Lakh invested in 2 years fixed deposit
- Rs. 1 Lakh invested in 5 years fixed deposit

Then, the average maturity of your FD portfolio is [(1 + 2 +5)/3] = 2.66 years. Ditto with debt funds (which have bonds maturing at different times)

The 3yr and 5yr historic returns are at 9.23% and 9.11%. For someone who has invested 3 years ago, would the return be 9.23% as on today?

Correct. This is past performance.

For HDFC Corporate Bond Fund the average maturity is 4.80 years and YTM is 5.42%. Also if someone continues to hold the investment after 3 years what would the returns look like?

After 3 years, we cannot say for sure because it is less than avg maturity of 4.8 years. However, if you invest now, after 5 years, you will have minimum 5.4% per annum returns.

Eventually, after 5 years, returns can be higher than this because the fund manager will always be looking for higher yields. Also, he will be buying underpriced bonds and selling overpriced bonds. If you are interested in the process of determining fair value of a bond, read up on "Bond valuation"
https://www.investopedia.com/terms/b/bond-valuation.asp

If he does not get such an opportunity, he will just hold on to the existing bonds till maturity.

[adithya.kp]

Hi @Smartcat
What are you doing for debt investments these days? ( I am not asking for specific recommendations). To me, gilt still looks a good category. If the 10 yr yield hovers around 5.87, it should be good I guess. But then nobody gets the interest rate cycle right.

Off topic: I think, the FED balance sheet expansion has completely spoiled the equity market. (Indian market too. Because of FIIs). Every day, some random stocks would go up. Index management is also very evident. Its like mean reversion to the old highs, which itself was overvalued to begin with. Fundamentals dont seem to matter at all. (I dont buy the theories like forward looking market etc). I have never experienced such an irrational market. The problem is that, it might go on for some more time. Would love to hear your views.

[SmartCat]

Originally Posted by adithya.kp

To me, gilt still looks a good category. If the 10 yr yield hovers around 5.87, it should be good I guess. But then nobody gets the interest rate cycle right.

You can always invest in 'regular' gilt funds, instead of 'constant maturity' gilt funds.
https://www.valueresearchonline.com/...s&tab=snapshot
If the fund manager believes that interest rates will rise, he can put up to 50% of the assets in treasury bills (risk free, 3 to 12 month duration)

And yeah, invest in gilt funds and hold on to it forever. Use it as a part of asset allocation. 60% in stocks and 40% in gilts is an OLD and often recommended strategy in the developed world.
https://www.google.com/search?q=60+4...hrome&ie=UTF-8

Gilt funds will generate guaranteed risk free (no defaults) returns over long term. And it partly reduces the volatility of your overall investments, because whenever there is a financial, economic or geopolitical crisis, gilt fund NAVs hit the roof.

Off topic: I think, the FED balance sheet expansion has completely spoiled the equity market. (Indian market too. Because of FIIs). Every day, some random stocks would go up. Index management is also very evident. Its like mean reversion to the old highs, which itself was overvalued to begin with. Fundamentals dont seem to matter at all. (I dont buy the theories like forward looking market etc). I have never experienced such an irrational market. The problem is that, it might go on for some more time. Would love to hear your views.

It basically boils down to interest rates. If interest rates are zero or close to zero, money starts going elsewhere looking for returns - primarily into stocks. Atleast, stocks generate 2% to 6% dividend yields. Think about it - what do you think everybody in India will do if India's bank interest rates is close to zero? People (including retired individuals) have to pull out money from fixed deposits and invest in stocks.

So markets/investors are not THAT irrational, eh?

More discussion in 'Understanding Economics' thread
https://www.team-bhp.com/forum/shift...nomics-54.html (Understanding Economics)

[Fx14]

Originally Posted by SmartCat

Probably because such funds have low expense ratio.

Well actually, most of the top performers in this category reflect similar expense ratios but have lower AUMs. Couple of funds with lower expense ratios reflect lower returns as well.

Which leads to a thought that probably, the smaller funds are more efficient at re-deploying the limited funds daily for marginally higher returns compared to the larger funds that may have to compromise on returns due to their size of daily allocations.

Only unsure if there are any red flags to look out for in case of smaller funds since there are no portfolio details visible for this category of funds.

[R_Gowardhan]

Originally Posted by ZenMaster

The wealth manager in our bank recently advised my dad to switch from Debt funds to either a Balanced Asset Fund or a Multi Asset Fund since the returns on the Debt funds were abysmal.
His advice was that Balanced Asset Fund was a good balance on Risk vs reward if our aim was "investment" or wealth creation.

Bankers / Bank Wealth managers for the sake of portfolio churning (read targets & Commission) may advise you to switch from one asset class to another with one or the other rationale seeming absolutely right. Not that they are always wrong or advising in their own interest, but having worked in the BFS Industry for the last 10 years, here are my 2 cents :

1. A hybrid fund (balanced / balanced advantage/ asset allocation funds) are actively managed funds and hence will have a higher expense ratio as compared to any debt fund. Additionally, hybrid funds are composed of Equity & Debt components where in the debt component may vary anywhere between 30-60% of the overall portfolio. Now, even for this debt portion of the fund portfolio, you will be bearing a higher (equity fund like) expense rather than what you would have paid if you would have invested the same proportion of money in a debt fund.

2. How long ago was the debt fund investment done? If less than 3 years, then I would suggest you also factor in the capital gains tax and exit load applicable on redeeming this investment. Once you add the same to the equation, the whole exercise of switching may not look as attractive.

3. The equity portion of the hybrid funds varies between 30-80%. While the branding of these funds may give them an image of "safe" funds, you are still taking on a substantial amount of risk - How these funds performed as on May this year is a testimony of how safe they are. Also, the Sensex & Nifty being at all time highs isn't the best time to make a Debt - to - Equity switch.

Please don't perceive my opinion as a criticism of Hybrid funds. They have a purpose and are right for people belonging to a particular risk appetite group. For someone already invested in a Debt Fund and nearing retirement / already retired, it may not be the best advise.