Stick to a few bond funds

NEW DELHI: For most mutual fund investors, bond funds can seem confounding. And with Sebi introducing 16 categories of bond funds as part of its recent scheme rationalisation exercise, matters have become even more complicated. So which among these funds are the must-haves?
To choose the right bond funds, investors must understand what purpose they serve in the portfolio.At the basic level, a bond fund is a cushion for the entire portfolio, meant to deliver steady returns. Vidya Bala, Head, Mutual Fund Research, FundsIndia, says, “Debt funds are meant to hedge exposure to more volatile asset classes.”

However, it is advisable to take a simplistic approach while building a bond fund portfolio, say experts. Investors need not look beyond two to three types of schemes.
The first choice should be a liquid fund, which invests in instruments with maturity of up to 91 days and it is the least complicated among all bond funds. “The returns are predictable, it lends stability to your portfolio with no accompanying credit or interest rate risk,” says Bala. Experts say a liquid fund is best utilised as an emergency fund, where one can park a part of one’s surplus cash instead of keeping the entire sum idle in the savings account. While the savings account yields only 3.5% pre-tax interest on your money, a liquid or low duration fund will fetch 7-7.5% return.
A liquid fund also allows the investor to redeem the money by the next working day. A handful of schemes even facilitate instant redemption up to a limit of ₹50,000 a day or 90% of the fund value, whichever is lower. This instant liquidity puts the liquid fund on par with a savings account. These funds can also be used when staggering investment into an equity fund using the systematic investment plan (SIP). It allows you to fetch a higher return compared to using a savings account to transfer the money.
The bread and butter portion of the bond portfolio should be in a low or short duration fund, says Kaustubh Belapurkar, Director, Fund Research, Morningstar Investment Advisor. These will invest in instruments with duration up to three years, and are suitable for investors looking to park money over a similar time horizon. These are not too exposed to interest rate risk as they carry low duration in their portfolio, yet are able to capture slightly higher return compared to a liquid fund.
Amol Joshi, Founder, PlanRupee Investment Services, says, “These funds provide the best of both worlds—yielding slightly better return while largely keeping volatility at bay.” For most investors, this combination of liquid fund and low duration fund is enough to fill the bond fund basket. Their returns are least affected by the changing interest rate scenario and carry little default risk.
Other categories of bond funds, however, require a deeper understanding of interest-rate risk, duration calls and credit risk. But if investors are keen on slightly higher return, then experts suggest rounding off the debt fund portfolio with a small allocation to a credit risk fund or even a dynamic bond fund. A credit risk fund generates higher returns by targeting lower rated corporate bonds carrying a higher coupon rate.
Currently, with corporate earnings recovery on the horizon, there is a higher possibility of lower rated paper getting upgraded, which can boost the returns from a credit risk fund. However, funds with poor credit profile can take a hit if companies default on loan repayments.
For the risk takers, a dynamic bond fund can provide another tactical play on interest rates. It attempts to capture higher return by aggressively shifting the portfolio between short and long duration according to expected movement in interest rates. Theoretically, these are ideal for investors who don’t have the understanding to take a call on interest movements. Yet, most dynamic bond funds have failed to live up to the billing and have often been caught on the wrong foot, hurting fund returns.
Other categories such as medium duration, long duration, corporate bond, banking and PSU fund, among others, can be safely ignored as they usually do not add much value to the lay investor’s portfolio.