Medium Duration Bond Fund - Unravelled
MF shots (part 7)- is an exclusive series of article which will try to explain in each category of mutual fund that exists. This article focuses on Medium Duration funds which invest for 3-4 years.
Estimated time to read - 7 minutes
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Overview –
The current article is continuation of MF shots series by Cellestial Wealth, where I try to decode various categories of mutual funds that exist. Previously I have written about short term debt mutual funds of which can be found by clicking on each category. Each article takes less than 6 minutes but states a few key pointers to be looked upon when choosing a category.
Overnight fund – invests in securities with maturity of 1 day.
Liquid fund – invests in securities with maturity of 91 days.
Ultra short duration funds – invests in securities with maturity of 3-6 months
Low duration funds - invests in securities with maturity of 6 months to 1 year.
Money market funds - invest in securities with maturity upto 1 year.
Short duration funds - invest in securities with maturity ranging from 1 to 3 years.
This article focuses on medium duration bonds.
Brief –
This category invests for medium term (i.e. 3-4 years) allowing it a very narrow range compared to other categories. The category hasn’t seen much interest from investors as it has Rs. 34,500 crores of AUM compared to 1 lakh crore of AUM generally seen in short term debt funds categories. But every category is designed to serve a purpose let’s unravel this category.
Investment objective –
The focus is on investing for 3-4 years. Higher investing duration allows it to earn slightly (+1-3%) outperformance over short duration funds which invest majorly for below 1 year duration.
Suitable for which type of goals –
1. Vacation funds accumulation
2. Children education fee payment in 2-3 years
Risk levels –
Risk levels are moderate as the time horizon is longer but this increases credit risk (risk of company default) in the portfolio. Although the managers try to minimize credit risk but the risk does exists. In economic downturn, credit events increase or company in which mutual fund has invested in faces headwinds (affected by negative factors).
What parameters to check –
1. Credit ratings of portfolio companies –
The portfolio of the debt fund needs to be looked upon necessarily as the underlying holdings bought by fund manager will ultimately determine the returns of an investor. The maturity & credit rating of security are a major look through.
2. Fund manager experience –
The experience of fund manager is crucial as discretion is provided to fund manager over security selection. Any negligence can prove costly to investor.
3. Distribution of government versus corporate securities –
As the category has higher duration, the investment of category is skewed more towards corporate securities which increase yield & risk at the same time. One needs to be watchful of over-exposure to corporates.
What to avoid -
1. Very high outperformance versus category –
A very high outperformance cant be sustained over longer periods of time without exposing portfolio to credit risk. A moderate outperformance (1-3%) is acceptable over benchmark.
2. Poor credit rating companies in portfolio –
Low credit rated securities yield higher returns but also carry significant risk of capital erosion along with it.
3. Very high expense ratio –
As outperformance historically has been modest a high expense ratio exceeding 1% is likely to further reduce returns. Be watchful of increase in expense ratio even after you have invested in it.
Interesting insights from this category –
1. Average expense ratio in the category is at 0.76% which is similar to that of active equity fund expense ratio of around 1%.
2. 4 segregated portfolios already exists out of total 16 medium duration funds.
3 . Almost 99% of AUM (34000 crore)is held by top 10 funds by AUM of this category (34,500 crore).
4. The lowest expense ratio is of Axis strategic bond fund of 0.39% & Nippon India Strategic fund has expense ratio of 1.41%.
Concluding thoughts –
The category overall has some overlaps with short duration fund which invests for 1-3 years & long duration funds which invests for 4 years & higher which has affected AUM flows in the category. The return & expense ratio are similar to those seen in short duration fund (invests for 1-3 years) & short duration fund category has already garnered 1.4 lakh crores of AUM. Also, due to higher duration of investment the funds have seen defaults which has lead to erosion of NAV in some cases & creation of segregated portfolio in some cases where credit quality or liquidity profile has deteriorated.
To me, the category doesn’t excite much given the overlapping nature coupled with modest outperformance which is achieved by short duration funds. One can overlook the category & rather invest in short duration (invests for 1-3 years fund) or medium to long duration fund (invests for 4-7 years) based on objectives.
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Notes -
Top 10 funds by lowest expense ratio -
Link to full excel sheet can be accessed here.
Top 10 funds by highest AUM -