Accrual Debt Funds Invest Online
Accrual Debt Funds - Your Companion in Times of Volatility
The Reserve Bank of India (RBI) has lowered repo rate by 125 bps in 2015 and more rate cuts may happen in 2016 after the announcement of the Union Budget. Trying to gauge which way interest rates will move is very difficult for retail investors. To give you a sense of this, here's a simple historical reference: the RBI has reduced the benchmark repo rate four times in the calendar year 2015, lowering it to 6.75% from 8.00%. Still, there is just a 50 basis points (bps) difference in the repo rate of today and of that almost a decade ago.
An investor in a debt mutual fund category must strike a balance between risk and return with stress on the credit quality of the portfolio. Accrual funds fit the bill in terms of risk adjusted returns and provide a means to diversify the debt fund portfolio.
Understanding Accrual Funds
Accrual funds by definition are those debt funds that invest in short- to medium-term debt instruments and focus on earning accrual interest income from the coupon bearing bonds in their portfolio. There is no separate category for accrual funds in the mutual fund industry and they are either clubbed under income or short-term funds.
With accrual funds, a fund manager looks for corporate bonds with appropriate yields and adopts a strategy of buy and hold. The focus is on generating returns through the coupon bearing bonds rather than making capital gains from rise in bond prices.
Accrual funds can be of two types based on their approach towards credit risk in the portfolio -
• Corporate bond funds follow the mandate of investing in higher credit rated papers and focus on fundamentals. They do not aim at generating higher returns by investing in lower grade papers.
• Credit opportunity funds on the other hand look for opportunity to take advantage of the difference in credit rating of papers and their fundamental attributes.
Pros and cons – Setting the context
When an investor opts for accrual funds, the objective is to allocate some amount in order to diversify and balance the total debt portfolio, rather than invest the entire corpus in them. The advantages include –
• Investors need not worry about the underlying interest rate scenario as the fund manager's mandate is to buy and hold. This works in both rising and falling interest rate scenarios.
The disadvantages include –
• With credit opportunity funds, there could be a chance of sharp fall in net asset value (NAV) due to credit rating downgrade or rating withdrawal.
Parameters for selecting accrual funds
An investor should look at the following before investing –
• Average maturity of the portfolio – The fund manager generally does not take duration calls and hence the average maturity of the portfolio should not change drastically with changing interest rate scenario.
• Credit rating of the portfolio – Focus shouldn't be only on the alpha generated by the fund manager. Stress should be on credit quality of the portfolio.
• Instrument allocation in the portfolio – Investors should look at the percentage allocation towards bonds/debentures and how much of the portfolio comprises of "cash and others".
• Others – Apart from the above, it is advisable to look at the investment objective, expense ratio and returns (comparison with benchmark index).
Last word
The present economic climate seems lucrative with the Government looking committed to reforms. Thus it seems that in this kind of a scenario, the probability of credit papers defaulting or witnessing a chance of degrading are less. Hence an investor may evaluate the option of allocating a certain portion of his investment in credit opportunities / accrual strategies.
Amid the interest rate volatility, accrual funds are gaining popularity among investors as they provide them an opportunity to diversify their debt fund portfolio.
The Reserve Bank of India (RBI) has lowered repo rate by 125 bps in 2015 and more rate cuts may happen in 2016 after the announcement of the Union Budget. Trying to gauge which way interest rates will move is very difficult for retail investors. To give you a sense of this, here's a simple historical reference: the RBI has reduced the benchmark repo rate four times in the calendar year 2015, lowering it to 6.75% from 8.00%. Still, there is just a 50 basis points (bps) difference in the repo rate of today and of that almost a decade ago.
An investor in a debt mutual fund category must strike a balance between risk and return with stress on the credit quality of the portfolio. Accrual funds fit the bill in terms of risk adjusted returns and provide a means to diversify the debt fund portfolio.
Understanding Accrual Funds
Accrual funds by definition are those debt funds that invest in short- to medium-term debt instruments and focus on earning accrual interest income from the coupon bearing bonds in their portfolio. There is no separate category for accrual funds in the mutual fund industry and they are either clubbed under income or short-term funds.
With accrual funds, a fund manager looks for corporate bonds with appropriate yields and adopts a strategy of buy and hold. The focus is on generating returns through the coupon bearing bonds rather than making capital gains from rise in bond prices.
Accrual funds can be of two types based on their approach towards credit risk in the portfolio -
• Corporate bond funds follow the mandate of investing in higher credit rated papers and focus on fundamentals. They do not aim at generating higher returns by investing in lower grade papers.
• Credit opportunity funds on the other hand look for opportunity to take advantage of the difference in credit rating of papers and their fundamental attributes.
Pros and cons – Setting the context
When an investor opts for accrual funds, the objective is to allocate some amount in order to diversify and balance the total debt portfolio, rather than invest the entire corpus in them. The advantages include –
• Investors need not worry about the underlying interest rate scenario as the fund manager's mandate is to buy and hold. This works in both rising and falling interest rate scenarios.
The disadvantages include –
• With credit opportunity funds, there could be a chance of sharp fall in net asset value (NAV) due to credit rating downgrade or rating withdrawal.
Parameters for selecting accrual funds
An investor should look at the following before investing –• Average maturity of the portfolio – The fund manager generally does not take duration calls and hence the average maturity of the portfolio should not change drastically with changing interest rate scenario.
• Credit rating of the portfolio – Focus shouldn't be only on the alpha generated by the fund manager. Stress should be on credit quality of the portfolio.
• Instrument allocation in the portfolio – Investors should look at the percentage allocation towards bonds/debentures and how much of the portfolio comprises of "cash and others".
• Others – Apart from the above, it is advisable to look at the investment objective, expense ratio and returns (comparison with benchmark index).
Last word
The present economic climate seems lucrative with the Government looking committed to reforms. Thus it seems that in this kind of a scenario, the probability of credit papers defaulting or witnessing a chance of degrading are less. Hence an investor may evaluate the option of allocating a certain portion of his investment in credit opportunities / accrual strategies.
Amid the interest rate volatility, accrual funds are gaining popularity among investors as they provide them an opportunity to diversify their debt fund portfolio.
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