Low Duration funds - True To Its Label?
MF shots (part 4)- is an exclusive series of article which will try to explain in each category of mutual fund that exists. This article focuses on Low duration funds.
Estimated time read - 5 minutes
Before we understand about low duration funds, here’ a recap of other short term debt funds I have covered till now (in case you missed out) –
1. Overnight fund – invests in securities with maturity of 1 day.
2. Liquid fund – invests in securities with maturity of 91 days.
3. Ultra short duration funds – invests in securities with maturity of 3-6 months
So, lets jump to low duration funds –
Brief –
There are total of 6 categories in short term debt funds. So, this article will be attempt to demystify low duration funds which has Rs. 157,000 crores of AUM stands currently invested in this category reflecting the popularity. It will also focus on investment objective, suitability, risk levels & most importantly What to avoid.
“Knowing what to avoid is equally important than what to look for.”
Investment objective –
The basic purpose behind creation of this category is to invest money for 6 months upto a year. These are beneficial when the interest rates are expected to increase in future & these are best positioned to benefit from interest hikes. The reason for outperformance in interest rate increase scenario is that the securities they hold mature within a year & they can reinvest the amount in latest issues which yield a higher interest rates. If interest rates fall, it will benefit more to the longer maturity funds.
Suitable for which type of goals?
Expenses/ goals which are expected to be in 6 months to 1 year.
Risk levels –
The risk levels seem to be low to moderate as these funds primarily invest in government securities, government backed companies or corporates. They invest in govt./ govt. owned companies to take care of liquidity & default risk which might be faced in corporate securities. The yield enhancement is done by adding corporate securities which yield more than government securities.
What parameters to check in Low duration funds –
1. Portfolio –
The quality of food you give to your cow, decides the quantity of milk. Same philosophy applies here too. The credit rating of the portfolio companies & their yield decide the returns you will earn.
2. Expense ratio –
Debt funds have lower returns compared to equity funds. Hence, with the lower returns, it becomes even more important to give a careful look at the expense ratio.
What to avoid
1. Past returns are irrelevant –
The RBI has reduced interest rates by 2-3% in past few years which has lead to higher past gains for investors holding these funds at that point in time. But the returns you will earn are based on current portfolio. Hence, ensure you give a careful look at the portfolio of the scheme.
2. Low credit quality companies in holdings –
The chances of reduction in capital returns are high if low credit rated companies are held in portfolio as default by a company will lead to reduction in NAV & hence eating up returns leading to losses. But majority of the funds try to avoid companies with low credit rating.
3. Investing with fund offering highest yield –
Some funds might invest in completely corporate securities which might earn the fund higher returns in the short term, but this might create troubles if the companies in the portfolio get into trouble.
Interesting insights from this category –
1. Majority (40-60%) the portfolio is invested in corporate issued securities & rest in govt. securities by majority of funds.
2. 2 outliers in the data out of total 25 low duration funds –
i. Franklin India low duration fund – it has expense ratio of 0.05% (category average 0.3%) but has invested completely in corporate securities & no investment has been made into government securities.
ii. Baroda Treasury Advantage Fund - Plan B – has negative returns for 2,3 & 5 years & has the highest expense ratio of 0.69%.
iii. Principal mutual fund has the lowest expense ratio (0.2%) & the lowest AUM in the category of 58 cr.
iv. Currently the funds have yield in the range of 3.5% to 4.5%.
Concluding thoughts –
This category serves three purposes –
i. Investing over the short horizon of time,
ii. Earning reasonable returns &
iii. Provides option to withdraw anytime.
In my opinion, this category is definitely worth it if one has either of 3 purposes stated above. The returns are comparable to other alternatives & keeping in mind the additional option of providing early liquidity to the investor without penaltiee.
Thanks for reading this article. Hope you liked the article. Have any feedback/ comments / suggestion let me know.
Notes -
Link to all available low duration funds.
Top 10 funds by AUM in the category.
Top 10 funds by lowest expense ratio.