Making sense of Short Term Debt Mutual Funds

This is the 5th post in the debt mutual fund investing series. You can find all the earlier posts here:

Part 1 – A primer for investing in debt mutual funds (Link)
Part 2 – 8 factor framework for analyzing any debt mutual fund (Link)
Part 3 – The ultimate guide to liquid funds (Link )
Part 4 –
Here’s a quick way to select Ultra Short Term Funds (Link )

Short Term Funds:

Short Term funds generally invest in debt securities with maturities ranging between 1 to 3 years. In other words the money is lent to different companies, banks, NBFCs ,government etc for 1 to 3 years. Since the tenure of lending is slightly higher for Short term funds compared to Ultra Short Term Funds and Liquid funds, most often we get marginally higher returns (which will be reflected in a slightly higher YTM)

I use this category of funds when my  investment horizon is more than 2 years and safety of capital is the priority. Think of this more like a decent alternative to Fixed Deposits.

These funds can take two risks to generate additional returns

  1. Interest rate risk
    The funds take a moderate interest rate risk to improve returns and mostly have a modified duration ranging between 1 to 3 years. So there is a possibility of higher returns if interest rates decline and vice versa. Most of them keep varying their modified duration within the range based on their interest rate view i.e will reduce the modified duration if the fund manager expects interest rates to go up and increase the modified duration if he expects the interest rates to go down. Some short term funds are more conservative and move the modified duration between 1-2 years while slightly aggressive ones move between 1-3 years modified duration.
  2. Credit Risk:
    In addition to the moderate interest risk , within the category, there are funds which additionally take credit risk as a strategy and those which avoid credit risk. Personally, I don’t like to take credit risk in my debt portfolios. I take risks via my equity portion and I am not too comfortable taking credit risk in my debt portion where “return of capital” is the priority over “return on capital”. Hence I first check for these funds which take credit risk and remove them from my list. But for investors who clearly understand credit risk and are willing to take the risk to generate additional returns, they can consider those funds which take credit risk (which is reflected in a higher YTM).

How to choose a Short Term fund ?

If you have gone through the earlier post on choosing Ultra Short Term funds (Link ), then you will be familiar with our simple approach – find funds with reasonable size, minimal credit risk, moderate interest rate risk and proven fund management teams.

As in the previous post we will be using the excel report from MOSL Research called Most MF Daily Score Card. You can download it here. (You need to create a login. No worries, it is free only)

There are a total of 58 Funds classified as Short Term funds.

Step 1: Knock off all schemes less than 1000 cr: 26 funds get knocked off and we are left with 32 funds.

Step 2: To check for credit quality – Knock off all schemes with % of AAA+ Sovereign + Call & Cash < 80%
Another 10 funds get knocked off and we are left with 22 funds

Step 3: Knock off funds with modified duration greater than 3 year
You can keep your own cut off here. I end up removing another 4 funds and I am left with 18 funds.

Step 4: Sort it according to 3Y returns and observe the max and min returns

Range of return outcomes:
3Y = 9.0% to 10.3%

Putting that in perspective, for every 1 lakh you invest in Short Term Funds the difference between the lowest and highest return fund in our final list in the last 3 years works out to be ~Rs 4,700. As expected the outcome ranges are pretty narrow and even if you end up with the lowest return fund it is definitely not catastrophic!!

So once we have arrived at this stage – we shall remind ourselves of the “paradox of choice” and instead of getting into analysis-paralysis our aim will be to find a “good enough” fund !!

Step 5: Stick to major AMC’s with reasonable track record and good debt fund management teams

I generally prefer funds from IDFC, ICICI, HDFC, Reliance, Axis, Birla Sun Life. Of course, that being my preference, you are free to pick any fund within these 18 schemes. Some schemes that I like are 1)IDFC SSIF – Short Term, 2)Birla SunLife Short Term Fund, 3)Axis Short Term Fund and 4)Kotak Bond Short Term Plan.

Short Term FundsSource: Morningstar, Value Research

In our next post, let us analyse the pros and cons of taking up credit risk to improve returns in debt fund portfolios.

Happy investing folks🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

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Investing Chitra Katha – Understanding the impact of modified duration on debt fund returns

Hi everyone. This is a new series I am attempting, where the idea is to simplify investing topics in the form of pictures.

In case, you want the detailed explanation on the topic you can always refer to our older post here

If you like this and would like to see similar simplified posts or have any suggestions, do let me know via your comments.

Happy investing 🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

Here’s a quick way to select Ultra Short Term Funds

In our last post, we figured out the basics of liquids funds and how to select an appropriate liquid fund (Link). Today let us move on to our next category – Ultra Short Term Funds.

Ultra Short Term Funds:

Ultra Short Term Funds (UST) are very similar to Liquid Funds in terms of their conservative nature. UST funds invest predominantly in debt securities which have a maturity of more than 91 days and less than 1 year. Due to the slightly higher maturity of underlying securities in UST funds compared to a liquid fund (which invests in debt securities which mature in less than 91 days) UST funds may have marginally higher returns over liquid funds. Logic being when you lend for a longer time frame you will require a higher interest rate from the borrower. This will be visible in the YTM (Yield to maturity) of the fund.

Typically we can use this fund for short term investment horizons of more than 3 months. (I use it up to to 2 years)

As always, by applying our simple framework (Link) we will primarily need to check for

  1. Interest rate risk that UST funds take to improve returns:
    The funds mostly have a modified duration ranging between 0.3 to 1 year (There are also few funds which are classified under UST and have modified duration as high as 1.8 years). Since we look at this category for short term and want only marginal levels of interest rate risk to improve returns, let us stick to funds which have modified duration less than 1 year. 
  2. Credit Risk:
    Typically since this category is meant for short term investments, most of the funds maintain a high credit quality in their portfolios i.e they have a high percentage of Sovereign (govt. bonds) and AAA and equivalent rated bonds (AA bonds can also be included unless you are ultra conservative). But that being said, there will always be some funds which invest a portion in lower quality debt securities (below AA rated) to have a higher YTM and hence show higher returns. Hence we must check for these funds which take credit risk. I personally don’t want credit risk when I invest in UST category as it is meant for short term and “return of capital” is the priority over “return on capital”. But for investors who clearly understand credit risk and are willing to take the risk to generate additional returns, they can consider those funds with higher YTM.
  3. Expense ratio:
    The expense ratio is generally around 0.10 to 0.60% for the category for direct plans. The lower the better.

How to select the right UST fund ?

Honestly there is nothing  such as the “one right” fund. What may be right for me might not work for you. So I shall take you through my logic of selecting the funds. Instead of focusing on the funds that I choose I would request you to check if the logic appeals to you. Once you are fine with the logic, you can either go with ones I choose or tweak around to figure out your own funds.

One of the biggest issues I face with the mutual fund industry is the mammoth no of choices it offers when it comes to choosing funds. While rationally, it looks like a great situation to be in, as you have large no of choices and hence can make better decisions. But unfortunately the truth is that more no of choices actually cause decision paralysis. If interested you can read about this interesting phenomenon called “Paradox of choice” here. Most of us (of course that includes me) will get into this decision-making paralysis. Hence the key is to remember that our selection process intends to find a “good enough” fund and not the no 1 fund (and the hard truth is no one can predict the no 1 fund of the future..why ?? well that is one of my favorite topics and I reserve it for another day)

So lets get to business..

The screener options in value research and morningstar do not provide Modified duration and hence to manually collate data for each and every fund is a nightmare. Finally I have found a reasonable hack to get through this.

Motilal Oswal Research publishes an excel report called Most Mutual Fund Daily. You can download it here . We will be using this for our selection process. While the sheet does have some problem as not all the cells are getting filled up and there is also a slight mismatch between some of its data and value research. However this is the closest I could get to a decent screener and hence kindly adjust with this at this juncture.

There are a total of 61 Funds classified as UST funds.

Step 1: Knock off all schemes less than 1000 cr. Since debt mutual funds are an Institutional dominated segment (i.e mostly it is the corporates who park their surplus cash in debt funds) I would prefer a larger sized scheme which will be able to handle  the impact of sudden redemption (selling) pressures if any. 27 funds get knocked off and we are left with 34 funds.

Step 2: To check for credit quality – Knock off all schemes with % of AAA+ Sovereign + Call & Cash < 80%
Another 11 funds get knocked off and we are left with 23 funds

Step 3: Knock off funds with Modified duration greater than 1 year
You can keep your own cut off here. I end up removing another 3 funds and I am left with 20 funds.

Step 4: Sort it according to 1Y, 2Y, 3Y returns and observe the max and min returns

Range of return outcomes:
1Y  = 7.6% to 9.0% 
2Y = 8.1% to 9.1%
3Y = 8.5% to 9.6%

Putting that in perspective, for every 1 lakh you invest in UST the difference between the lowest and highest return fund in our final list in the last 1 year works out to be Rs 1,400 (for 2 years it is Rs 2,172). So the most important thing to notice is that the outcome ranges are pretty narrow and even if you end up with the lowest return fund it is definitely not catastrophic!!

Takeaway – once you have arrived at this stage – remember the “paradox of choice” and we are only looking for a “good enough” fund !!

Step 5: Stick to major AMC’s with reasonable track record and good debt fund management teams

I prefer funds from IDFC, ICICI, HDFC, Reliance, Axis, Birla Sun Life. In fact I have a bias towards IDFC as they are the only fund house where the fund manager regularly communicates (you can find them here) and hence as investors it is easy for us to understand what is happening in their funds. I sincerely wish other AMCs follow suit (Axis does a decent job but still not upto IDFC).

Now technically you are free to pick any fund within these 20 schemes. I would prefer IDFC Ultra Short Term Fund – Direct Plan and Reliance Money Manager – Direct Plan (Reliance has a nice app which allows me to easily invest in their direct scheme. Check the details here . Again just to clarify, I have no connection with neither IDFC or Reliance AMC and you are free to pick any fund of your choice)

UST Funds

In effect what we are essentially trying to do is to reduce credit risk, emphasize reasonable size, take moderate interest rate risk and stick to good fund managers!!

I hope you found this useful. In our next post, let us cover short term debt funds and how to select a “good enough” short term fund.

Happy investing folks 🙂

(P.S – In case you have a better screener source, method or suggestion, feel free to add it in the comments section. As always, I would love to be wrong and hope to keep learning from my mistakes. Looking forward to learn from all of you)

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

The Ultimate Guide to Liquid funds

This is the 3rd post in the debt mutual fund investing series. If you have the time, it would be great if you could go through the earlier posts in this series –

Part 1 – A primer for investing in debt mutual funds (Link 1)
Part 2 – 8 factor framework for analyzing any debt mutual fund (Link 2)

There are primarily 8 categories of debt funds:

  1. Liquid Funds
  2. Ultra Short Term funds
  3. Short Term funds
  4. Income Funds
  5. Dynamic Funds
  6. Accrual or Credit Funds
  7. FMP
  8. MIP

Phew..8 categories ..this seems to be complicated..

So instead of breaking our head over the complexities, lets try and break it down to the basics and nail down the few categories which will matter the most to us. In fact for my personal investments, I like to keep it extremely simple and stick to only the first three categories i.e Liquid, Ultra Short Term and Short Term Funds !! So hang on for a while and we will get this thing sorted.

If we strip down all the jargon, the underlying difference across the categories simply boils down to what type and extent of risk are the funds taking to improve returns via

  1. Interest rate risk (measured via modified duration)  
  2. Credit risk (measured via the % of portfolio with lower than AA securities))

With this in mind, let us explore various categories..

For all temporary parking of money which we need within 1 year, we can consider
       1. Liquid funds – upto 3 months
       2. Ultra Short Term funds – 3 to 12 months

Liquid Funds (Think of it as an alternate to Savings Bank Account)

Liquid Funds invest with minimal risk in short term debt instruments with a maximum maturity of 91 days. This is captured in the “Average Maturity” and in practice, for most funds it averages to less than 2 months. They have the lowest risk and are ideal for parking temporary money.

(Ignore if you find it a little technical: The instruments where liquid funds invest generally include CBLO, certificate of deposits (i.e short term lending to companies), commercial papers (short term lending to companies) and treasury bills (short term lending to government) and term deposits (bank FD) )

While investing in Liquid funds generally returns are not the top priority. I mean have you ever worried about your savings bank account paying you only 4%. The priority is safety, liquidity (i.e can be taken out anytime) and returns – in that order.

So as expected, these funds do not take credit risk as they are predominantly invested in AAA equivalent bonds and also do not take interest rate risk (they have very low modified duration) to improve returns. This basically implies that liquid fund NAV returns will generally be very stable as the underlying returns are predominantly driven by interest income (from the underlying debt securities) which accrue everyday.

Approximate Return Expectation from a liquid fund = Net YTM = YTM-Expense ratio

Also remember that while investing in liquid funds, if interest rates increase our returns also increase and if interest rates decline then our returns will also decline. 

Liquid funds for people like us can be used in several ways. For eg

  1. Temporary parking: For eg, every month when I get my salary, I immediately park my intended savings in a liquid fund. Then as and when I find time, I transfer it to equity funds or any other option which I like at that juncture.
  2. For systematic transfer plans into equity funds: Sometimes you may have a large amount of money which you don’t want to put in equities at one shot. So you may put it in a liquid fund and do a systematic transfer plan into equity funds or manually move it as and when you want.

So how do we select our liquid fund??

The first advantage when it comes to selecting a liquid fund is that the chances of a big mistake is not there. Since most of them prioritize liquidity, do not take credit risk (except for a select few funds which may take minimal credit risk to show better performance) and have very low modified duration, the returns across different liquid funds is generally in a narrow range and most of the return differential can be explained in terms of expense ratio and portfolio composition.

In terms of the portfolio composition, the returns are higher in the order of Commercial paper (CP) > Certificate of deposit (CD)  > Treasury bill (T Bills). T Bills and Certificate of deposits are more liquid compared to Commercial Papers. A liquid fund with higher exposure in commercial papers is considered to be more volatile as these securities are generally not as liquid as CDs or T-Bill.  So the fund may be producing higher returns but will also have a slightly higher risk. Hence if you are extremely conservative choose a fund which has a lower % of Commercial Papers).

Simple steps to choose our required liquid fund

  1. Stick to large AMCs
  2. Check credit quality
  3. Go for a fund size above 1000 cr
  4. Lower the expense ratio the better

When it comes to Debt funds, I generally prefer to stick to major AMCs such as ICICI, HDFC, Reliance, Kotak, IDFC, Axis etc. Is there something wrong with other AMCs. Of course not but given the narrow range of return outcomes I am more comfortable investing via the larger names. Some funds under the large AMCs are ICICI Prudential Liquid Plan, Reliance Liquid Fund – Treasury Plan, IDFC Cash Fund, HDFC Liquid Fund, Kotak Liquid fund, Axis Liquid fund. You can consider any of the above. I generally use IDFC Cash Fund. If you want more options you can check here – Link

Snapshot
Liquid Fund Data

Most importantly, let’s not get too lost in the tendency to over analyse (which yours faithfully gets caught into often), as anyway the return differential is not going to be too high and the primary reason for using liquid funds is for safety, liquidity, convenience and of course some reasonable returns.

In fact when I was researching for this article , I found that there is a new app called Finozen which has just started with the premise of letting you switch back and forth between a savings bank account and liquid fund. I never thought someone could build a business model around liquid funds. But nevertheless simplicity always has its charm. They have a nice 30 second video on liquid funds. Do check if you have the time – Link (by the way I have no clue on who they are..nor am I recommending them..Found the idea to be interesting and hence the mention 🙂

At the current juncture the Net YTM (i.e YTM- Expense ratio) for most of the liquid funds work to be around 7%. So the daily returns going forward assuming interest rates remain the same will be roughly 7%/365 = 0.019%. This implies that if I invest Rs 1 lakh, I can expect approximately Rs 19 to get added everyday.

Now while liquid funds are for all practical purposes extremely safe and provide better returns than an SB account, we also need to be aware of some possible risks.

  1. Sharp increase in interest rates:
    On 16-Jul-2013, India was going through a currency crisis due to the announcement of Fed Taper. As a result there was a sharp increase in interest rates of up to 2% leading to negative returns in liquid funds for a day. Kindly go through the articles to understand what really happened –  Link 1 Link2

    Now what if we had a similar scenario like that repeat and interest rates went up by 2%. Taking the example of IDFC Cash Fund, it currently has a Net YTM = YTM-Expense ratio of 6.95%. Therefore daily returns from interest accrued is 6.95%/365 = 0.019% or Rs 19 added per day for every 1 lakh invested. It has modified duration of 0.08 years – which means that the negative NAV impact in our fund for a 2% increase in interest rate would be a  -2%*0.08 =-0.16%. Now if you adjust for the interest income everyday (i.e 0.019%) then the negative impact will be -0.14%. Or in other words, Rs 1 lakh investment would be roughly down by Rs 140 to Rs 99,860. This is equivalent to 0.16%/0.019% = 9 days of usual returns in the fund. Now remember that our Net YTM has now increased from 6.95% to 8.95%. Therefore daily returns from interest accrued post the interest rate increase is 8.95%/365 = 0.025% or Rs 25 added per day for every 1 lakh invested. So to compensate for the loss of -0.14%, we will need to wait for 0.14%/0.025% (or Rs 140/Rs25) i.e approximately 6 days.

    While these are rare events, whenever they occur there will be a lot of panic which will be disproportionately exaggerated by the business news channels. So if in case something like that happens, the most important thing is not to panic as we clearly know how liquid funds derive their returns and to remember that its only a matter of waiting for 7-10 days before we tide over our temporary decline. 

  2. Crisis scenarios leading to significant redemption from the funds and the fund not able to sell underlying securities due to low liquidity (read as no buyers):
    When this scenario happened last time during 2008, since redemptions were high from liquid funds and buyers were not there, few funds were forced to liquidate their underlying debt securities at lower prices thereby taking an NAV impact. The larger AMC’s were able to tide over this as they arranged for temporary loans/support from their sponsors after which RBI came to the rescue. So this is the reason why I generally stick to large AMC’s with strong debt fund management teams.

Parting Thoughts:

  1. Think of Liquid funds as an alternative to our Savings Bank account
  2. Typically used for parking of money for time periods upto 3 months
  3. No credit risk and extremely low modified duration
  4. Returns are predominantly from interest income – hence daily NAV movement is extremely stable
  5. Returns across different liquid funds is generally in a narrow range
  6. Hence, opt for well established funds with strong pedigree

So with that we come to the end of our liquid fund analysis and I hope you found it useful. Next week we shall discuss the remaining categories.

Happy investing 🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

8 factor framework for analysing any debt mutual fund

Just in case you are new to this blog (which most probably you will be :)), you can read the first part of this series here Link

Debt Fund Returns
=
Interest from underlying debt securities
+
Price changes in the market value of underlying debt securities
(based on interest rate changes)

or in other words..

Debt Fund Returns everyday (Yield to maturity/365) + (-1*Modified duration*
% change in YTM)

8 factor framework for investing in any debt mutual fund

  1. Yield to Maturity – Expense Ratio
  2. Credit Quality: % of government, AAA and AA rated bonds
  3. Modified Duration
  4. Average Maturity
  5. Size
  6. Exit Load
  7. Historical NAV movement graph
  8. Returns

1.Yield to Maturity – Expense ratio
This will approximately be equal to the returns that you can expect from the fund in a year if there is no change in the interest rates (read as yield to maturity)

2.Credit Quality: % of government and AAA rated bonds
This is to check if the fund is taking any credit risk. The higher the % of AAA and government securities in the portfolio of debt mutual fund, lower is the credit risk i.e probability of default or downgrade in the fund. Even AA papers are fine to a certain extent.

A debt fund which is taking credit risk will have a higher yield to maturity (because when you are lending to a lower rated borrower you would demand a higher interest rate). So the Yield to maturity level compared to other funds can also be used as a proxy to find out if the fund is taking credit risk.

I personally prefer funds which do not take credit risk and have a high % portfolio allocation in either government bonds or AAA securities.

3. Modified Duration
Check this number to figure out if the fund is undertaking any interest rate riskHigher the modified duration higher is the interest rate risk i.e sensitivity to interest rate changes. Also check if the modified duration will be actively managed i.e will the fund manager regularly adjust the modified duration based on his interest rate view. If the fund is actively managed then the fund manager will typically try to increase duration if he expects interest rates to fall and vice versa.

4.Average Maturity 
This no in my personal opinion is not too important but provides you a sense of tenor of the debt securities that the fund holds. The lower the tenor the lower is the interest rate risk. Few also interpret this number (some also use modified duration) as an approximate indicator of the time for which an investor must typically be invested in the fund. It is also used to ascertain the category of the fund. (Liquid, Ultra Short Term, Short Term, Income – in increasing order of average maturity)

5.Size
Fund size is important as flows are normally of a significant size (because corporate companies are major investors in debt funds). Further, trading in the debt market requires huge minimum lots. A reasonably sized debt fund helps the fund manager to meet redemptions (read as investors taking money out of the fund) without resorting to distress sales and also provides sufficient size to trade in debt securities. Personally, I would be comfortable with a fund that has a size more than INR 500 cr at least.

6.Exit Load
An Exit Load is the fee charged by mutual funds if an investor wishes to withdraw his investment in mutual fund within a specified period from that fund. This charge is calculated as a percentage of the NAV and not on the amount you invest. The lower the exit load period the better!!

7.Historical NAV movement graph
Provides you a sense of the historical volatility in the returns of the fund.

8. Returns
Also just have a look at the fund’s historical returns and its performance vis-a-vis the peer group. We typically need a fund which has performed over a long period and most importantly has done it consistently.


Enough of theory, let’s take the example of a few funds and apply the framework..

I will be using value research online (link) and morningstar website (link) for all my analysis

Example 1: HDFC Liquid Fund – Growth

HDFC Liquid Fund -8

1.YTM – Expense Ratio

= 7.28%-0.41% = 6.87%

So 6.87% is the annual return to be expected from the fund if the YTM remains the same. Expense ratio seems reasonable.

Daily stable return portion = 6.87%/365 =0.019% every day gets added to the NAV

i.e for every Rs 1 lakh invested Rs 19 will get added everyday

2.Credit Quality 

HDFC Liquid Fund -9

As seen above ~98.5% of the underlying debt securities are in AAA bond securities. Hence the fund is not taking any credit risk to improve performance.

But, the fact that the fund is not taking any credit risk right now does not mean that it won’t take any credit risk in the future. So let us also check its historical credit quality for getting a better idea.

HDFC Liquid Fund -5

As seen above the fund has historically maintained above 98% in AAA bond securities for the last 5 years and therefore we can reasonably conclude that the fund does not take credit risk.

3. Modified Duration

The modified duration is 0.14 years. This implies that if the interest rates (read as YTM) goes down by 1% (i.e from 7.28% to 6.28%) then the NAV will increase by 0.14% and if instead the interest rates goes up by 1% then the NAV will reduce by 0.14%. Thus as seen, the impact due to interest rate changes are minimal as the fund has low modified duration.This also implies that the fund has not undertaken any interest rate risk to improve returns.

4.Average Maturity

The average maturity is 0.14 i.e 0.14*365 which is around 51 days. This will also help us ascertain the category of fund (but let us leave that for the next post).

5.Size

The size is at Rs 30,622 cr and is comfortably above our threshold of Rs 500 cr.

6.Exit Load
HDFC Liquid Fund -Exit Load

There is no exit load for the fund which is good.

7.Historical NAV Graph

HDFC Liquid Fund -4

From our analysis so far, we know that the fund does not take credit risk and interest rate risk. Hence the returns must be pretty stable as it is only driven by the interest income which is the YTM (Yield to maturity) component. We can confirm that from the above 10 year NAV movement chart of the fund which shows extremely smooth movement in NAVs.

8.Historical Returns

You can check them from the above chart. As seen, the fund has consistently outperformed its category average in all the years.

Final thoughts:

Thus if I were to invest in the fund I will expect approximately around 6.87% returns from the fund provided interest rates stay around the same levels. If interest rates go down then my returns will also go down (as the YTM component goes down and so does your daily return i.e YTM/365) and if instead the interest rates go up then my returns will also correspondingly improve. (Note: Since modified duration is very low I am not taking into account the underlying debt security price changes due to interest rate movement.)

Example 2: IDFC Super Saver Income Fund – Short Term Plan

IDFC Super Saver Income Fund   Short Term Plan   - 11.YTM – Expense Ratio

= 7.48%-0.80% = 6.68%

The expense at 0.80% seems to be on the higher end (must check with other funds in the category on how much are they charging)

So 6.68% is the annual return to be expected from the fund if the YTM remains the same.

Daily stable return portion = 6.68%/365 =0.18% every day gets added to the NAV

i.e for every Rs 1 lakh invested approximately Rs 18.3 will get added everyday

2.Credit Quality 

IDFC Super Saver Income Fund   Short Term   Regular Plan  3

As seen above ~90.5% of the underlying debt securities are in AAA bond securities and remaining in AA bond securities (slightly lower than AAA in terms of quality but still acceptable). Hence the fund is not taking any credit risk to improve performance.

But, the fact that the fund is not taking any credit risk right now does not mean that it won’t take any credit risk in the future. So let us also check its historical credit quality for getting a better idea.

IDFC Super Saver Income Fund   Short Term   4

The fund has historically stuck to AAA and AA bond securities for the last 5 years and therefore we can reasonably conclude that the fund does not take credit risk.

3. Modified Duration

The modified duration is 1.61 years. This implies that if the interest rates (read as YTM) goes down by 1% (i.e from 7.48% to 6.48%) then the NAV will increase by 1.61% and if instead the interest rates goes up by 1% then the NAV will reduce by 1.61%. Thus as seen, the impact due to interest rate changes on the NAV while not significantly high is still there, as the fund has consciously included some modified duration.This also implies that the fund has consciously undertaken moderate interest rate risk to improve returns.

4.Average Maturity

The average maturity for the underlying debt securities is 1.91 years

5.Size

The size is at Rs 4,458 cr and is comfortably above our threshold of Rs 500 cr.

6.Exit LoadIDFC Super Saver Income Fund   Short Term Plan  2There is no exit load for the fund which is good.

7.Historical NAV Graph

IDFC Super Saver Income Fund   Short Term   Regular Plan  5

From our analysis so far, we know that the fund does not take credit risk but however takes some bit of interest rate risk. Hence the returns must have some intermittent volatility based on the NAV impact due to interest rate movements which adds on to the stable interest income component. We can confirm that from the above 10 year NAV movement chart of the fund which shows mostly smooth but intermittent volatility in NAVs.

8.Historical Returns

You can check them from the above chart. As seen, the fund has consistently outperformed its category average in all the years except for 2010.

Final thoughts:

Thus if I were to invest in the fund I will expect approximately around 6.7% returns from the fund if interest rates stay around the same levels. My returns will be higher than 6.7% if interest rates go down.If they go down by 1% since my modified duration is 1.61 years my NAV returns will spike up by 1.61%. So in this case my overall returns will be around  6.7%+1.6%= 8.3%. So if your expectation is for the interest rates to go down, then this type of a fund makes a lot of sense. But what is the catch? Yup you guessed it right. If interest rates move up by 1%, then your returns will become 6.7%-1.6%=5.1%.


So we have basically figured out how to interpret returns from a debt fund. You can try applying the same framework for different debt funds on your own.

In our next post, we will understand different debt fund categories, when to use them and how to select funds.

If you have any queries do let me know via the comments or mail. Hope to keep learning from all of you and as always happy investing folks 🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments