[SmartCat]

Originally Posted by warrioraks

it seems to be averaging returns over and above 7% consistently. I am going to definitely consider this fund category as an alternate to traditional FDs.

Originally Posted by adimicra

Based on your risk profile, I think Axis Banking & PSU fund is a good choice. Hope it helps

Originally Posted by JediKnight

With the current repo rate I don't think a risk averse short term debt fund can generate more than 5.5 to 6% returns in the medium term.

Gents, no need to extrapolate or guess future returns of a particular debt fund. All you need to do is look up its "Yield to Maturity" and "Average Maturity".

Eg: Axis Banking & PSU debt fund
https://www.valueresearchonline.com/...-psu-debt-fund

Look up the "Portfolio Aggregates" table:



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.

[carboy]

Originally Posted by SmartCat

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.

What about the interest rate risk? If RBI increases the interest rates, then the NAV of all debt funds (except the overnight or very short term debt funds) will go down which will affect the returns?

[SmartCat]

Originally Posted by carboy

What about the interest rate risk? If RBI increases the interest rates, then the NAV of all debt funds (except the overnight or very short term debt funds) will go down which will affect the returns?

Interest rate risk in debt funds is basically "volatility risk". That is, NAV of this fund can go up and down depending on fall/rise in short term (up to 2 yr) interest rates. But if you hold for 2 years, there is a guarantee of 4.5% per annum returns (assuming there are no defaults) in this particular fund. By design, the NAV will recover to the published yield to maturity % levels after 1.9 years. That's because interest will be accrued on the bonds over time, pushing up the NAV.

If you do not fear defaults, it can be profitable to average down a debt fund. That is, if NAV falls 10% over the next month, yield to maturity of this particular fund will become 5% (roughly 10% higher). If you bring in fresh capital after NAV fall, you will get higher returns on that incremental capital.

Since there is no default risk in g-sec/gilt funds, averaging down such funds if there is a significant NAV fall is a no-brainer. But averaging down a credit risk fund might not be such a great idea.

[anandhsub]

The return in any bond is based on 2 factors.

1) the yield to maturity. This is the annualised return that you make if interest rates do not change.

Ie. If a bond has an yield to maturity of 5% then you will make 5% an year if interest rates don't change

2) the capital gain or loss based on change in interest rates. This is the duration risk and is measured by the duration of bond.

If the duration of the bond is listed as 2 yrs what this means is that an 1% change in interest rates will lead to 2% change in the price of the bond. There are also other concepts like convexity and roll down which play a role.

Hence for a debt fund when interest rates go up you do get lower returns but it might not be a negative return if the yield to maturity compensates for it.

Short term funds have very low duration. Hence the duration risk is negligible. Hence you get higher returns as interest rates go up (higher yield to maturity) and lower returns as interest rates go down.

[carboy]

Originally Posted by SmartCat

Interest rate risk in debt funds is basically "volatility risk". That is, NAV of this fund can go up and down depending on fall/rise in short term (up to 2 yr) interest rates. But if you hold for 2 years, there is a guarantee of 4.5% per annum returns (assuming there are no defaults) in this particular fund.

I don't think there are any guarantees even assuming no defaults.

Originally Posted by SmartCat

By design, the NAV will recover to the published yield to maturity % levels after 1.9 years. That's because interest will be accrued on the bonds over time, pushing up the NAV.

Any time the interest rate goes up, the bond prices change and the MF has to accordingly adjust it's daily NAV to reflect the current market price of the bond.The fund continuously keeps buying & redeeming bonds - because bonds keep maturing & also new people keeping investing in the MF & because people also keep redeeming their MFs all at different times. So right on the day you sell (and also many other people sell), they may not be able to pay you back fully by just using the money from bonds which matured the previous day. So they will have to sell other bonds which have not matured in order to fulfill your sale. All these bonds will not be 2 years old. There may be bonds which have been bought a couple of months back etc etc. Overall there is no guarantee that you will get a particular rate of interest. That guarantee holds only if external interest rates are fixed. Which they aren't.

[SmartCat]

Originally Posted by anandhsub

1) the yield to maturity. This is the annualised return that you make if interest rates do not change.

Originally Posted by carboy

I don't think there are any guarantees even assuming no defaults.

This is incorrect. If you still have doubts, just google "yield to maturity".
https://en.wikipedia.org/wiki/Yield_to_maturity

The yield to maturity (YTM), book yield or redemption yield of a bond or other fixed-interest security, such as gilts, is the (theoretical) internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond is held until maturity, and that all coupon and principal payments are made on schedule

What is applicable to an individual bond is applicable to a bond mutual fund too. Yield to maturity is the minimum returns you are likely to get, if the fund manager does not take stupid decisions (Eg: selling a higher yield bond & buying a lower yielding bond OR loading up a fund with lower quality/liquidity bonds). The reason why bond mutual funds are considered conservative is because there is guarantee of returns (if there are no defaults), if you hold for the average duration of bonds. That is why it is recommended to conservative investors.

Investing in bond mutual fund is NOT a speculative bet on interest rates.

[prateekm]

Originally Posted by SmartCat

This is incorrect. If you still have doubts, just google "yield to maturity".
https://en.wikipedia.org/wiki/Yield_to_maturity

Is there a way to get YTM for different periods? For example, let's assume I invest 100 INR in a liquid fund today and hold it for a year, what could be the approximate returns I'd get?

[SmartCat]

Originally Posted by prateekm

Is there a way to get YTM for different periods? For example, let's assume I invest 100 INR in a liquid fund today and hold it for a year, what could be the approximate returns I'd get?

Liquid funds hold securities with a 1 to 2 months maturity. Think of it as a 1 month bank fixed deposit.

Now, if you invest Rs. 1 Lakh in this 1 month bank deposit, and renew it every month, what kind of returns will you get at the end of the year? The answer is "it depends" on what the bank does with the interest rates over a period of 12 months.

Ditto with liquid funds. The returns you earn over a period of 1 year is uncertain. But what's certain is returns over a period of 0.1 years (average maturity). You have to look at "Yield to Maturity %" in conjunction with "Average Maturity (yrs)"

Eg: if you hold HDFC liquid fund for a period of 1 month, you will get (3.25/12) = 0.27% return (yield to maturity divided by 12, since 3.25% is annualized returns)
https://www.valueresearchonline.com/...fc-liquid-fund

[anandhsub]

Originally Posted by SmartCat

This is incorrect. If you still have doubts, just google "yield to maturity".
https://en.wikipedia.org/wiki/Yield_to_maturity



What is applicable to an individual bond is applicable to a bond mutual fund too. Yield to maturity is the minimum returns you are likely to get, if the fund manager does not take stupid decisions (Eg: selling a higher yield bond & buying a lower yielding bond OR loading up a fund with lower quality/liquidity bonds). The reason why bond mutual funds are considered conservative is because there is guarantee of returns (if there are no defaults), if you hold for the average duration of bonds. That is why it is recommended to conservative investors.

Investing in bond mutual fund is NOT a speculative bet on interest rates.

What you are referring to is true in fixed maturity plans where the manager just buys bonds and holds to maturity.

However in a debt fund, the manager has to hold a certain avg duration. Which means he cant just buy one bond and hold to maturity. he will buy a few bonds of various maturity and keeping managing them such tha the avg duration doesn't change a lot. This is especially true in the constant maturity gilt funds but broadly similar for most debt funds.

Hence as interest rates go up or down you do face duration risk. however as long as the volatility of interest rates is not very high the yield to maturity will compensate for it.

For eg. below is the chart of the NAV of the SBI gilt fund vs the India 10y yield. As you can see whenever the yields all sharply the NAV goes up sharply, while when yields slowly correct higher the NAV has broadly remained constant. It is only in very sharp up moves in yields that you face a loss.



Overall in this period the return in the Gilt fund was ~26%, of which about 13% came from the yield to majority ( ~6-7% yield to maturity for just less than 2 yrs) and the remaining 13% due to the capital gain as interest rates fell from 7.5% to 6%.

[SmartCat]

Originally Posted by anandhsub

For eg. below is the chart of the NAV of the SBI gilt fund vs the India 10y yield. As you can see whenever the yields fall sharply the NAV goes up sharply, while when yields slowly correct higher the NAV has broadly remained constant.

Correct. In a bond fund, NAVs can go up and down like a stock. But if you hold a particular bond mutual fund for appropriate duration (depends on the category of fund), there is no need to worry about interest rates or NAV movements.

That's why one needs to understand 'yield to maturity' and 'average maturity'. Choose your investment horizon first and pick an appropriate bond fund (based on avg maturity)

- Typical maturity of g-secs is 10 yrs
- Typical maturity of corporate bonds is 1 to 3 years
- Typical maturity of liquid/money market bills is 1 month to 6 months.

Example 1:

If you have a time horizon of 3 years, and if you invest in gilt funds, then you are speculating about interest rates. You have to worry about NAV volatility. But if you have an investment horizon of 7 to 10 years, and you are investing in constant maturity or normal gilt funds, then your portfolio will generate the published "yield to maturity" returns at the end of 7 to 10 years. You don't have to worry about NAV volatility.

Example 2:

If you have an investment horizon of 6 months and you invest in "Corporate Bond" category of funds, you have to worry about NAV volatility. But if you have an investment horizon of 3 years and intend to cash out only after 3 years, short term NAV movements should not bother you. NAV of this "corporate bond fund" is guaranteed to hit new highs (as long as there are no defaults) at the end of 3 years.

That is the reason why ALL debt fund NAVs keep hitting new highs. Debt fund managers are not super heroes who can magically figure out interest rate movements. It is just simple maths. It is by design.

[carboy]

Originally Posted by SmartCat

That is the reason why ALL debt fund NAVs keep hitting new highs.

All Debt fund NAVs hitting all time high means is that you are not suffering a capital loss. But if the increase is less than the current interest rate, then it may mean that you are actually losing money as compared to keeping it in a FD.

For e.g. if the NAV is 100 today, and it is 102 after a year, it means you have only earned 2% interest over a year.

Take for e.g. the Aditya Birla Corporate Bond fund whose chart you have provided. If you bought that in 2009 & held it till 2011, you would have just earned around 6% per annum on it. Whereas you could have got far more by putting it in a much safer FD in a bank. Why did this happen - it was because interest rates went up in those 2 years so the bond NAVs went down. A MF may not be able to keep all bonds to maturity, they would have to sell when redemptions happen.

[SmartCat]

Originally Posted by carboy

Take for e.g. the Aditya Birla Corporate Bond fund whose chart you have provided. If you bought that in 2009 & held it till 2011, you would have just earned around 6% per annum on it. Whereas you could have got far more by putting it in a much safer FD in a bank.

You bought into the fund in 2009. Why did you exit in 2011 when you know that the average maturity of a corporate bond fund category is 3 years plus? I have clearly mentioned this in the previous post:

Originally Posted by SmartCat

If you have an investment horizon of 6 months and you invest in "Corporate Bond" category of funds, you have to worry about NAV volatility. But if you have an investment horizon of 3 years and intend to cash out only after 3 years, short term NAV movements should not bother you. NAV of this "corporate bond fund" is guaranteed to hit new highs (as long as there are no defaults) at the end of 3 years.

Average maturity of entire category of corporate bond funds currently is 3.35 years and Aditya Birla Corporate bond fund is 3.46 years
https://www.valueresearchonline.com/...rate-bond-fund



So if you want to compare returns, check the returns between 2009 and midway between 2012 and 2013. By exiting earlier than "average maturity" of a debt fund, you are not investing - you are speculating on interest rates.

[carboy]

Originally Posted by SmartCat

You bought into the fund in 2009. Why did you exit in 2011 when you know that the average maturity of a corporate bond fund category is 3 years plus? I have clearly mentioned this in the previous post:

Buy it in 2009 & exit in mid 2012 - again just 6.5%. If you had looked at the agreed interest rates of the held bonds in early 2009, it would have probably been higher than 6.5% (I can't remember bond interests being so less in that time period). But you didn't necessarily get that yield when you sold it. The point being, it's not guaranteed.

[SmartCat]

Originally Posted by carboy

If you had looked at the agreed interest rates of the held bonds in early 2009, it would have probably been higher than 6.5% (I can't remember bond interests being so less in that time period). But you didn't necessarily get that yield when you sold it. The point being, it's not guaranteed.

I don't remember either, and you cannot say yield to maturity of this fund in 2009 "probably would have been higher"

Right now, yield to maturity of Aditya Birla Corporate bond is 5.2% and SBI 3 year bank FD is 5.3%
https://www.etmoney.com/fixed-deposi...ank-fd-rates/2



Key takeaway: Aditya Birla Corporate Bond fund is a terrible investment right now from risk-reward point of view. Over the next 3 years+, you are likely to get 5.2% pa returns in ABSL Corporate Bond fund (carries default risk), which is equal to SBI fixed deposit returns (almost no default risk).

[SmartCat]

One more parameter that finds a mention in valueresearchonline is "Modified Duration (Yrs)". However, I don't think this nomenclature is correct. It is actually called "Macaulay Duration"



Now, the Macaulay Duration of Aditya Birla Corporate Bond fund is 2.72 years. What this essentially means is: If you invest in this fund now, it will take a maximum of 2.72 years to get your NAV back - even if RBI increases interest rates to 10% pa or 20% pa or infinity & beyond.

Essentially, to secure your principal under all circumstances, you need to remain invested for atleast 2.72 years.