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RETAIL RESEARCH 
Features & Performances of sub-categories of Income Funds: 
Key Facts: 
October 17, 2014 
Mutual Fund Cat...
RETAIL RESEARCH 
Risk as measured by Standard Deviation for all Debt categories: 
Income Category Vs. Other Debt categorie...
 Credit Risk: This is risk associated with default on interest and /or principal amounts by issuers of fixed income secur...
 At its Fourth Bi-monthly Policy review, the RBI has reiterated its target for CPI to bring down to 6% level by January 2...
RETAIL RESEARCH 
Narrowing CAD in the domestic economy: 
Liquidity placed at comfort zone (provided by the RBI): 
Moderati...
RETAIL RESEARCH 
Performance of Income sub-categories during various interest rate cycles: 
Sub-classification of Income F...
with the daily periodicity). Considering the falling and rising interest rate scenarios (Chart 2), Credit Opportunities Fu...
RETAIL RESEARCH 
Portfolio Asset break-up of Pure Income sub-category: 
Rating profile of the debt instrument they investe...
RETAIL RESEARCH 
Portfolio Asset break-up of Dynamic Income sub-category: 
Rating profile of the debt instrument they inve...
RETAIL RESEARCH 
Average Maturity (Years): 
Performance: As far as trailing returns are concerned, the Dynamic Income fund...
RETAIL RESEARCH 
Portfolio Asset break-up of Credit Opportunities sub-category: 
Rating profile of the debt instrument the...
Portfolio: The latest data show more than 60% of the assets are invested in the AA & below rated instruments. These scheme...
RETAIL RESEARCH 
Rating profile of the debt instrument they invested in: 
Portfolio: Over 90% of the portfolio (as per the...
RETAIL RESEARCH 
Portfolio Asset break-up of Corporate Bond sub-category: 
Rating profile of the debt instrument they inve...
RETAIL RESEARCH 
Average Maturity of Medium term sub-category: 
Rating profile of the debt instrument they invested in: 
A...
Better performing schemes from Medium Term Income sub-category: 
Scheme Name 
RETAIL RESEARCH 
Latest 
Corpus 
(Rs 
Crs) 
...
Advantage of investing in Income funds: 
 Actively managed: The fund managers of the Income funds seek to generate return...
Changes in the corpus (Rs Crs) of the sub-categories of Income Funds: 
Only the sub-categories ‘Credit Opportunities’ and ...
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HDFC Sec Note - Mutual Fund Category Analysis - Income Funds

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Features & Performances of sub-categories of Income Funds

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HDFC Sec Note - Mutual Fund Category Analysis - Income Funds

  1. 1. RETAIL RESEARCH Features & Performances of sub-categories of Income Funds: Key Facts: October 17, 2014 Mutual Fund Category Analysis – Income Funds  What are they? Income Funds (otherwise called as Long Term Income Funds) invest in across the debt instruments such as government securities, corporate debts, PSU bonds, securitized debt, money market instruments and CBLO. They are actively managed schemes aiming to generate better returns from the opportunities available from the debt market.  Sub-classification: The schemes in the income funds category follow different investment approaches as mandated. There are 92 schemes coming under Income funds category, out of which 33 schemes are pure income funds while 24 schemes follow dynamic investment strategy. Apart from these, 7 schemes invest in the debt instruments that the banks & PSUs issue, 5 schemes invest majorly in corporate bonds, 13 schemes try to benefit out from the credit opportunities available in the debt market, 2 inflation indexed bonds and 8 schemes invest in the medium term maturing debt instruments.  Investment Strategies: The schemes follow various investment strategies including duration strategy, dynamic strategy, accrual, capital appreciation, invest in relatively lower rated debt instruments to benefit from relatively higher rating, etc. Regular income funds invest across the debt instruments such as government securities, corporate debts, PSU bonds, securitized debt, money market instruments and CBLO. Further certain portion of assets is kept as cash equivalents. Dynamic Income funds follow flexible asset allocation strategy of churning their investments into any debt instruments with any tenor.  Performance: Overall Income Funds category showed middling returns compared to other debt oriented categories. However, sub-categories in the income funds such as Credit Opportunities Funds, Corporate Bond Funds and Banking & PSU debt Funds delivered notable returns both in short term and long term.  How do Income Funds work for investors? Debt mutual funds gain in two ways - one from interest income and another from capital appreciation. Short term debt instruments whose maturity periods range from one day to one year mostly work on accrual basis to account for interest income. On the other hand, long term debt instruments can get benefit in both ways - from interest income and capital appreciation. Capital appreciation arises from the bonds once the value of the bonds rise. Interest rates and prices of debt securities move in opposite direction. When interest rates rise, the prices of debt securities fall. Likewise, when interest rates fall, the prices of debt securities rise.  Risks Involved? As mentioned, debt funds investments are exposed to risks such as interest rate risk, credit risk, spread risk, liquidity risk, counterparty risk, re-investment RETAIL RESEARCH risk, etc.  Tax Implications: Investing in income funds are tax efficient. The investment kept in the growth option of the income funds for at least 3 years is eligible to get the long term capital gain tax (LTCG) benefit of paying 20% with indexation. However, the investments redeemed within 3 years attract short term capital gain tax that is to be paid as per the investors’ tax bracket. In dividend option, any dividend in the investors’ hand is exempted from tax. However, the AMC pays the Dividend Distribution Tax of 28.33% for retail investors from the distributable income.
  2. 2. RETAIL RESEARCH Risk as measured by Standard Deviation for all Debt categories: Income Category Vs. Other Debt categories: Income Funds Vs. Other Debt Oriented Categories (based on Rolling Returns): Income funds posted mediocre returns albeit scheme specific returns are commendable… Debt Oriented Categories 3 Month Absolute 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR Gilt Funds - LT 1.78 3.41 6.51 6.38 6.64 Gilt Funds - ST 1.80 3.60 7.11 6.74 6.46 Income Funds 2.00 3.98 7.50 7.58 7.58 Short Term Income 2.09 4.16 8.32 8.22 8.16 Ultra Short Term 2.11 4.20 8.32 7.96 7.74 Liquid Funds 2.06 4.11 8.09 7.58 7.29 Note: NAV/Index values are as of Oct 08, 2014. Top 2 performers are highlighted by yellow. Returns are rolling calculated from the last 4 years NAV history. Income Funds Vs. Other Debt Categories – in various interest rates cycles: Risk associated with investing in Income Funds:  Interest Rate Risk: Market value of fixed income securities is generally inversely related to interest rate movement. Accordingly, value of portfolio of the scheme may fall if the market interest rate rise and may appreciate when the market interest rate comes down.
  3. 3.  Credit Risk: This is risk associated with default on interest and /or principal amounts by issuers of fixed income securities. In case of a default, scheme may not fully receive the due amounts and NAV of the scheme may fall to the extent of default.  Spread Risk: Credit spreads on corporate bonds may change with varying market conditions. Market value of debt securities in portfolio may depreciate if the credit spreads widen and vice –versa. Similarly, in case of floating rate securities, if the spreads over the benchmark security / index widen, then the value of such securities may depreciate.  Liquidity Risk: Liquidity condition in market varies from time to time. In an environment of tight liquidity, necessity to sell securities may have higher than usual impact cost. Further, liquidity of any particular security in portfolio may lessen depending on market condition, requiring higher discount at the time of selling.  Counterparty Risk: This is the risk of failure of counterparty to a transaction to deliver securities against consideration received or to pay consideration against securities delivered, in full or in part or as per the agreed specification. There could be losses to the Scheme in case of a counterparty default.  Re-investment Risk: Investment in fixed income securities carries re-investment risk. Interest rates prevailing on the coupon payment or maturity date may differ from the purchase yield of the security. This may result in final realized yield to be lower than that expected at the time of purchase.  Economic Risk: A slowdown in economic growth or macro-economic imbalances such as the increase in central and state level fiscal deficits may adversely affect investments in the country. The underlying growth in the economy is expected to have a direct impact on the volume of new investments in the country. Present scenario in Indian Debt Market:  The macro-economic conditions in India seem to be improving going forward on the back of formation of stable and progressive central government and its stronger policy actions.  However, the outcome from macro-economic indicators have been mixed bag as stable Liquidity conditions, better than expected GDP growth, narrowing CAD number, shortened fiscal deficit, downtrend in the inflation are favorable for the bond market while increased geo-political issues, disappointing IIP growth, emergence of inflationary expectations on the back of lower monsoon and increased fuel prices and the RBI’s policy stance seem to weighing the bond market negatively going forward.  Geo-political events have been the driving factors for the past few months weighing the domestic and global markets badly. Fed policy stance in US has been the important trigger to decide the directions for the global markets especially the liquidity flow into emerging markets. On domestic side, Liquidity conditions continued to be kept stable by the RBI, with total system liquidity maintained around 1% of NDTL. This has softened the short term yields.  The GDP growth for the quarter ending June 2014 was reported at 5.7% YoY Vs 4.6% in the previous quarter, the highest growth witnessed in the last two-and-a- half years. The uptick was largely driven by better than expected growth in agriculture sector and financial services sector. RETAIL RESEARCH
  4. 4.  At its Fourth Bi-monthly Policy review, the RBI has reiterated its target for CPI to bring down to 6% level by January 2016. This has ruled out any cut in the repo RETAIL RESEARCH Falling Yields tend to generate higher returns for Income funds: rate in the near term at least till end of this financial year.  The IIP data came disappointed as it remained unchanged at 0.4% in August against 0.5%, which was later revised to 0.4%.  The retail inflation numbers stayed below 8% for the third consecutive month wherein the consumer price index (CPI) inflation for the month of August was at 7.8%. The Wholesale Price Index (WPI) based inflation came in August at a five year low of 3.74% (lower than the 5.19% yoy for July month).  To conclude, Notwithstanding no changes in policy rates since Dec 2013, the bond markets have factored some positive development with the improvement seen in the government and RBI’s policy actions on controlling Fiscal Deficit, lowering inflation, improving CAD and emphasizing the growth path for the Indian economy. However, the yields of the 10 year benchmark gilt saw a rise of 132 bps from the last bottom level of 7.16% seen in June 04, 2014. Latest data shows that the benchmark 10-year security ‘8.40% GOI 2024’ closed at the yield of 8.37% as on Oct 16, 2014. The RBI has been reiterating the importance of bringing down the CPI number to its comfort zone of 6% level by January 2016. Considering this, one can understand that there will be no rate cut in the near term at least till end of this financial year. The continued improvement in inflation data, Government’s policy initiatives to support growth will likely to create room for the RBI to cut policy rates in the first quarter of the FY16. Narrowing down of Corporate Spreads throws up investing opportunities:
  5. 5. RETAIL RESEARCH Narrowing CAD in the domestic economy: Liquidity placed at comfort zone (provided by the RBI): Moderating 10 year G sec benchmark yields: Trending down of WPI Inflation numbers:
  6. 6. RETAIL RESEARCH Performance of Income sub-categories during various interest rate cycles: Sub-classification of Income Funds category: The schemes in the income funds category follow different investment approaches. There are 92 schemes coming under Income funds category. Based on the investment strategy, they are further classified as; 1. Pure Income Funds (33). 2. Dynamic Income Funds (24). 3. Credit Opportunities Funds (13). 4. Banking & PSU debt Funds (7). 5. Corporate Bond Funds (5). 6. Inflation Indexed Funds (2) and, 7. Medium Term Income Funds (8). Among the sub-categories, Credit Opportunities Funds, Corporate Bond Funds and Banking & PSU debt Funds have showed better performance based on the trailing returns, Rolling Returns (calculated for last 4 years) and the performance during various interest rate cycles. However, there are specific schemes from the other sub-categories that have also delivered higher returns. Performance of sub-categories of Income Funds based on Rolling Returns:  The above chart 1 shows that the schemes from Credit Opportunities Funds, Corporate Bond Funds, Banking & PSU debt Funds and Medium Term Income Funds showed relatively better performance during various time frames on rolling returns basis (Rolling returns calculated from the last four years NAV history
  7. 7. with the daily periodicity). Considering the falling and rising interest rate scenarios (Chart 2), Credit Opportunities Funds and Corporate Bond Funds showed notable performance. They saw a notable rise in NAV during falling interest rates and corrected less during rising interest rate scenarios in comparison to other sub-categories. The below table also portrays the same (returns on various periods based on point to point returns).  As for as the risk measured by the Standard Deviation for the sub-categories of the Income Funds are concerned, Banking & PSU debt Funds, Corporate Bond Funds and Credit Opportunities Funds are placed in the lower risk profile side. At the same time, Inflation Indexed bonds and Dynamic Income funds are higher risky schemes among the sub-categories of the Income Funds (see the chart below).  Another reason for the better performance showed by the Banking & PSU debt Funds, Corporate Bond Funds and Credit Opportunities Funds are their investment strategy of maintaining the lower duration. These sub-categories have maintained their Average Maturity close to 2 years. Lower duration funds tend to generate higher returns during the scenarios where prevailing higher interest rates or there is an uncertainty seen in the direction of the movement of the interest rates in an economy. Relative performance of the sub-categories of the Income Fund category in various time frames (based on trailing returns): Income Funds Sub-categories 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR Banking & PSU Debt 4.58 9.03 7.97 8.87 Corporate Bond 4.74 9.21 9.22 9.52 Credit Opportunities 5.67 10.62 9.02 9.36 Dynamic Income Funds 6.03 8.70 7.61 8.78 Pure Income Funds 5.84 8.82 7.33 8.38 Inflation Indexed Funds 4.84 6.58 Medium Term 5.38 9.13 8.11 8.76 Note: NAV/Index values are as of Oct 08, 2014. Top 2 performers are highlighted by yellow. RETAIL RESEARCH Average Maturity (Years) of the sub-categories of the Income Fund over the last 3 years: Risk profiling of the sub-categories of the Income Fund based on Standard Deviation:
  8. 8. RETAIL RESEARCH Portfolio Asset break-up of Pure Income sub-category: Rating profile of the debt instrument they invested in: Average Maturity (Years): Sub-category 1: Pure Income Fund There are 33 schemes coming under this sub-category. They are pure vanilla, actively managed income schemes, follow conservative investment approach and allocate maximum of assets with AAA/A1 rated debt instruments. They are long term bond funds focusing investment in high quality fixed income instruments across segments ie, G Secs, Corporate Bonds and Money Market instruments. They try to generate a total return made up of both interest income, and changes in the value of capital. They give equal importance to short term as well as long term perspective. They minimize the risks from liquidity, credit and interest rates in a balanced manner. The pure income schemes do not follow purposely any duration strategy. However, the portfolio duration will be decided based on the fund manager’s assessment of expected movement in interest rates, liquidity conditions and other macro-economic factors. According to the latest data, the category Average Maturity maintained at 7.44 years while the Modified Duration maintained at 4.63 years. Performance: The pure income funds posted middling returns in comparison to other sub-categories in the income funds category. However, scheme specific returns are commendable as the schemes such as AXIS Income Fund, ICICI Pru Long Term Plan and UTI-Bond Fund posted decent returns over periods. The performance of the schemes in the category in the rising interest rate scenarios has been poor due to its conservative investment style. However, they showed comparatively better returns during falling interest rate scenarios. Portfolio: The Portfolios of the schemes are mainly dominated with AAA/A1 rated instruments. They follow the balanced approach of investing in short term and long term debt papers. However, the recent periods shows the increased investments in Government securities. Any kind of risk profile investors who want debt diversification can consider the better performing schemes from the sub-category.
  9. 9. RETAIL RESEARCH Portfolio Asset break-up of Dynamic Income sub-category: Rating profile of the debt instrument they invested in: Better performing schemes from Pure Income Category: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv (Low risk) AA & Equiv (Medium risk) A & Eqiv (High risk) SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR AXIS Income Fund (G) 140 1.84 9.69 6.00 12.31 10.12 74.68 6.38 10.77 7.67 3.91 6.89 7.99 0.16 ICICI Pru Long Term Plan - Retail (G) 86 0.35 10.61 6.33 16.27 82.34 8.93 14.08 11.16 10.60 4.33 8.18 7.59 7.40 0.16 UTI-Bond Fund (G) 1913 1.86 5.00 5.60 15.26 4.96 0.53 69.96 7.05 8.53 7.88 8.90 4.19 8.23 8.20 8.01 0.20 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of pure Income Category 1.63 7.44 4.36 24.39 21.06 20.98 54.70 5.84 8.82 7.33 8.38 3.74 6.99 7.15 7.21 0.15 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24 Note: NAV value as on Oct 06, 2014. Crisil data source: ACEMF. Sub-category 2: Dynamic Income Funds: There are 24 schemes are coming under this sub-category. They strategically deploy the funds to take advantage from interest rate risks. Their objective is to earn returns mainly in the form of capital gains and interest income also. Dynamic Income funds have flexibility to churn their investments into any debt instruments including corporate and PSU bonds, Government Securities, money market instruments, securitized debt etc of varying tenors. They have the leeway of going 100% only in cash or in Corporate debts or in Gilts or in any others debt instruments at any point of time. The debt market offers its risk-to-return tradeoff from the changes in interest rates and their impact in the prices of the bonds. When the interest rates decline, the value of the bonds shoots up. Likewise when the interest rates rise, the value of the bonds falls. This interest rate risk is converted as returns by doing dynamic and active management implementing yield curve strategies. The main difference between Dynamic income and other income funds is that in income funds, the fund manager gives equal importance to short term as well as long term perspective while in Dynamic Income funds, fund manager gives importance to the cycle and try to capitalize from the opportunities.
  10. 10. RETAIL RESEARCH Average Maturity (Years): Performance: As far as trailing returns are concerned, the Dynamic Income funds delivered average returns compared to other income funds. The last six months performance by schemes has been good compared to other sub-categories. But, the performance based on rolling returns, have been poor. That means that their performance has not been consistent. The schemes showed better performance only during few interest rate cycles. Portfolio: The dynamic income funds actively churned their assets during the varying interest rate scenarios. The recent portfolio data show the increased exposure into G sec instruments and decreased exposure into corporate bonds and money market instruments. The recent narrowing down in the credit spread seems to throw some opportunity to increase the exposure into corporate debts. As far as Average Maturity is concerned, the category saw increased their Average Maturity of the portfolio from 5 years to 7.7 years in the last six months period. The following schemes are better performing schemes from the category. Better performing schemes from Dynamic Income Category: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Equiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Months Absolute 1 Year CAGR 2 Years CAGR 3 Years CAGR Birla Sun Life Dynamic Bond Fund (G) 8581 1.18 4.26 6.18 9.14 0.13 85.90 6.17 10.43 8.52 9.39 4.23 8.34 8.41 8.67 0.14 UTI-Dynamic Bond Fund (G) 387 1.04 1.00 5.40 8.91 16.61 45.07 6.52 11.06 9.33 10.21 4.70 9.50 9.77 9.46 0.09 HDFC High Interest Fund - Dynamic (G) 820 1.55 13.28 6.86 17.76 1.83 76.90 7.62 10.37 8.32 9.25 3.81 7.45 7.45 7.54 0.21 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of Dynamic Income Sub-category 1.54 7.51 4.70 30.47 7.01 60.29 6.03 8.70 7.61 8.78 3.82 7.37 7.41 7.52 0.17 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24
  11. 11. RETAIL RESEARCH Portfolio Asset break-up of Credit Opportunities sub-category: Rating profile of the debt instrument they invested in: Average Maturity (Years): Sub-category 3: Credit Opportunities Funds There are 13 schemes coming under this sub-category that showed notable performance compared to other sub-categories. They invest predominantly in corporate bonds seeking opportunities across the credit curve and get benefit from superior yield by taking a marginally higher credit risk. They take calls based on the interest rate movements and changes in the credit spreads over sovereign yields. These schemes prefer to invest in corporate debt securities seek to give extra return on the credit spread over gilts. Credit portfolio management of the schemes is guided by external credit ratings assigned by any of the recognized credit rating agencies like CRISIL, CARE, ICRA and others. These schemes prefer to invest in AA and A rated papers given their attractive yields. Normally, lower rated debt securities bear higher coupon rates than that of the highest rated papers due to their comparatively lower creditworthiness. However, fund managers normally do not compromise on the credit worthiness of bond issuers hence the risk of default in mutual fund portfolio is very low. The credit research carried out on every instrument prevents possibility of a default and the consequent loss in the debt portfolios. It is worth noting to say that there is no active management or value add in a portfolio that contains only AAA rated debt securities (except the timing of entry), wherein the inclusion of AA and A (not below these ratings) enables fund managers to take more active calls (on creditworthiness and timing) which may result in achieving higher returns with taking a bit higher risk. Further, fund managers bet on lower rated bonds from companies with strong fundamentals with the intention that these papers may be upgraded in rating in the near future. This will add up extra value on the portfolio. The schemes in the category posted notable returns during the short term as well as long term compared to other sub-categories of income funds. They are placed in the top of the better performing income schemes’ list based on the trailing, rolling and the performance during different interest rate cycles. The outperformance shown by the schemes was mainly attributed to the efficient call strategy taken by the fund managers on adopting accrual strategy rather than rolling down the yield curve. The maximum exposure into such ‘A’ and ‘AA’ rated instruments boosted the returns of the schemes.
  12. 12. Portfolio: The latest data show more than 60% of the assets are invested in the AA & below rated instruments. These schemes seek opportunity from the lower rated papers from both long term as well as short term instruments. The portfolio duration is always kept in the range of 3 – 4 years for most of the schemes and the average maturity is kept the maximum of 6 years. The low modified duration coupled with minimal portfolio average maturity resulted in achieving higher returns with lower risk. To conclude, credit opportunities is one of the best performing sub-categories in the Income funds. They have delivered comparatively better returns. This is suitable for any risk profile investors with minimum 2 years time horizon. RETAIL RESEARCH Portfolio Asset break-up of Banking & PSU sub-category: Better performing schemes from credit opportunities Income Category: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Equiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Months Absolute 1 Year CAGR 2 Years CAGR 3 Years CAGR Birla Sun Life Medium Term Plan (G) 3334 1.45 2.23 1.85 21.46 38.07 34.03 5.69 11.23 10.46 10.69 4.86 9.58 9.45 9.56 0.06 Franklin India Corpo Bond Opport (G) 6804 1.82 2.88 2.60 8.63 47.38 38.50 5.83 11.17 9.63 4.91 9.68 9.82 0.07 Franklin India IBA - (G) 1402 1.96 10.93 6.73 9.56 33.80 17.68 15.68 6.83 11.13 9.32 10.45 4.57 8.97 8.80 8.34 0.13 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of Credit Opportu Sub-cat 1.82 3.00 2.25 26.65 47.00 23.45 15.68 5.67 10.62 9.02 9.36 4.33 8.61 8.60 8.32 0.07 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24 Sub-category 4: Banking & PSU debt Funds There are 7 schemes coming under this sub-category. These schemes follow active investment strategy and focus on investment opportunities in the debt instruments issued by Banks and PSUs. Though these schemes follow concentrated investment approach of allocating majority of their assets only on Banks and PSUs papers, they maintain the credit risk low by investing in higher quality instruments as Banks and PSUs issuances are regarded as safe investment instruments and are more liquid. They further invest in Gilt Securities and State Development Loans in order to maintain an optimum balance of yield, safety and liquidity.
  13. 13. RETAIL RESEARCH Rating profile of the debt instrument they invested in: Portfolio: Over 90% of the portfolio (as per the latest portfolio of Aug 2014) has been invested in highest safety ‘AAA/A1’ rated banking and PSU papers. The schemes allocated between banking and PSU papers depending on the interest rate view. They mostly invested in short maturity high quality instruments to keep credit risk low. The Average Maturity has been maintained close to 2 years by all the schemes except Franklin India Banking & PSU Debt Fund. The recent portfolios of the schemes contain hardly any allocation into G secs while equal allocation made between short term and long term instruments. Performance: The track record for the category is very limited except Baroda Pioneer PSU Bond Fund as most of the schemes in the category were launched in the recent periods. However, the recent performance of the sub-category has been decent compared to other sub-categories. DSP BR Banking & PSU Debt Fund and JPMorgan Ind Banking & PSU Debt are the top performing schemes from the category. Better performing schemes from Banking & PSU debt Funds Income Category: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Equiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR DSP BR Banking & Psu Debt Fund (G) 281 0.89 2.17 1.70 95.14 4.75 9.58 4.85 9.63 0.05 JPMorgan Ind Banking & PSU Debt(G) 228 0.57 2.21 1.81 74.26 12.79 5.43 10.01 4.91 10.00 0.07 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of Banking & PSU Debt Sub 0.76 1.89 1.44 91.07 8.20 14.04 4.58 9.03 7.97 8.87 4.53 9.12 8.28 8.16 0.05 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24 Sub-category 5: Corporate Bond Funds There are 5 schemes coming under this sub-category. These schemes invest predominantly in corporate bonds and most of them seek a high level of accrual income by investing into medium to long term corporate papers available at a spread over market yields. Further, a favorable risk‐reward trade‐off makes corporate bonds an attractive investment option. These schemes are suitable for investors who want to benefit from high accrual and the prospect of capital appreciation of the fixed income securities over the long term.
  14. 14. RETAIL RESEARCH Portfolio Asset break-up of Corporate Bond sub-category: Rating profile of the debt instrument they invested in: The present scenario in the domestic economy seem to be favorable for these schemes like policy actions taken by the new government, FII inflows and emergence of domestic debt market and so on. Increase inflows from FIIs within this space to create additional demand for short to medium maturity corporate bonds. Increase in issuance from the private sector across rating profile would increase liquidity in the Space. Rating profile of companies is likely to be upgraded due to better business environment. Portfolio: The last six months portfolio of the schemes shows the increased allocation into corporate bonds to more than 80% of the assets. Corporate bonds schemes are differing from the credit opportunities funds as the former is conservative and not that much keen on capitalizing the opportunities from the credit spread. However, the increased allocation into ‘AA & below’ rated papers close to 40% level in the recent portfolio show the active management of benefiting from the higher yields. Meanwhile, they maintained lower Average maturity ranging 1.2 Years to 4.2 Years. They have invested in the higher rated debt instruments of the companies across manufacturing, services, non‐banking financial companies, banks, etc. Performance: The track record for the category is very limited except SBI Corporate Bond and Principal Debt Opp Fund Conservative as most of the schemes in the category were launched in the recent periods. However, the recent performance of the sub-category has been decent compared to other sub-categories. Better performing schemes from Corporate Bond sub-category: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Equiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Months Absolute 1 Year CAGR 2 Years CAGR 3 Years CAGR SBI Corporate Bond Fund (G) 157 0.87 1.27 1.12 81.95 13.84 4.51 9.83 9.68 9.86 4.56 9.04 8.38 7.96 0.03 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of Corporate Bond Sub-category 0.96 2.45 2.01 51.82 32.62 21.76 0.02 4.74 9.21 9.22 9.52 5.11 9.04 8.38 7.96 0.06 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24
  15. 15. RETAIL RESEARCH Average Maturity of Medium term sub-category: Rating profile of the debt instrument they invested in: Average Maturity (Yrs): Sub-category 6: Medium Term Income There are 8 schemes coming under this sub-category. These schemes optimize returns by keeping its portfolio weighted average maturity between 3 years and 7 years taking a view of the interest rate environment and various parameters of the Indian and global economy. In case of a rising interest rate environment the duration/average maturity of the schemes may be reduced whereas in a falling interest rate scenario the holding in medium / long securities may be maximized between 2 to 7 years. At present the portfolio Average Maturity has been kept at 2.67 years. The low modified duration coupled with minimal portfolio average maturity resulted in achieving higher returns with lower risk. Portfolio and Performance: The performance of the Medium Term Income sub-category has been notable in the recent periods especially for the last two years when the domestic debt market witnessed flat or narrow movements in their yield curve. Medium term income schemes mostly follow accrual strategy holding with the combination AAA and AA & A rated debt instruments. An allocation of close to 25% of assets into AA and A rated instruments which are having maturity profile of not more than 2 years helped the schemes to achieve better returns during the periods. The recent portfolio of the category shows the increased exposures into corporate debts having the residual maturity not more than 4-5 years. The performance based on the rolling returns over the short term periods has been notable for the schemes. Medium Term Income Funds are all weather funds as they generate above average returns in all the interest rate cycles by taking exposure into low duration debt investments. A partial allocation into AA rated papers also resulted in increasing the portfolio value. Any investors who want to have fixed income diversification can consider and hold at least 2 years.
  16. 16. Better performing schemes from Medium Term Income sub-category: Scheme Name RETAIL RESEARCH Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Equiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Months Absolute 1 Year CAGR 2 Years CAGR 3 Years CAGR HDFC Medium Term Opportunities Fund (G) 2119 0.29 2.10 1.68 82.96 12.92 5.41 10.22 8.78 9.41 4.43 9.02 9.30 8.96 0.08 IDFC SSIF - MTP - Plan A (G) 1742 1.51 2.61 2.10 53.37 19.10 22.85 4.88 8.55 7.51 8.57 3.92 7.98 8.48 8.77 0.09 Reliance Medium Term Fund - (G) 2002 0.57 0.55 0.52 80.72 17.49 4.39 9.16 8.69 9.10 4.30 8.52 8.08 7.82 0.03 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Average of Medium Term Income Sub-cat 0.98 2.67 2.02 62.31 24.80 12.99 11.33 5.38 9.13 8.11 8.76 4.85 8.35 8.43 8.37 0.07 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24 Sub-category 7: Inflation Indexed Funds There are 2 schemes coming under this sub-category - DWS Inflation Indexed Bond Fund and HDFC Inflation Indexed Bond Fund. The fund invests in the inflation linked securities, predominantly issued by the Government, with the intention to deliver inflation adjusted returns to the investors. Inflation Indexed Bonds (IIBs) are bonds issued, mainly by the Government, that have the coupon and principal linked to inflation. The Govt. of India has been issuing IIBs linked to WPI and CPI (Consumer Price Index) targeted at wholesale and mass-retail market respectively. The current outstanding issuance is Rs. 6500 crores. The IIBs issued by the Government of India have their coupon and principal payments linked to inflation as measured by the Wholesale Price Index (WPI) and a tenor of 10 years. They have posted below average returns since launch. The investment options for these schemes are limited. Further, there is no indication of launching of additional or new Inflation Indexed Bonds in the market. Liquidity in the secondary market is also poor. Investors can wait for sometimes to let the schemes to prove their mettle. Performance of Inflation Indexed Funds: Scheme Name Latest Corpus (Rs Crs) Expense Ratio (%) Average Maturity (Years) Modified Duration (Years) % of allocation into rated debt instruments Trailing Returns (%) Rolling Returns (%) Standard Deviation (Daily) AAA & Equiv AA & Equiv A & Eqiv SOV 6 Month Absolute 1 Year CAGR 2 Year CAGR 3 Year CAGR 6 Months Absolute 1 Year CAGR 2 Years CAGR 3 Years CAGR DWS Inflation Indexed Bond Fund (G) 117 1.03 7.84 7.09 12.12 86.87 3.69 2.46 0.22 HDFC Inflation Indexed Bond Fund (G) 1 1.25 NA NA NA NA NA NA 5.98 6.58 1.50 2.84 0.24 Benchmark: Average of Overall Income Category 1.47 5.79 3.66 36.56 23.14 22.05 52.11 5.68 9.07 7.78 8.70 3.98 7.50 7.58 7.58 0.13 Crisil Composite Bond Fund Index 7.26 10.94 7.47 8.24
  17. 17. Advantage of investing in Income funds:  Actively managed: The fund managers of the Income funds seek to generate returns from varying interest rate cycles. Fixed deposits, on the other hand, carry re-investment risk. When a deposit matures and is reinvested, you may fall into a low interest rate regime and get lower returns than before.  All-weather funds: Debt funds can also act as a cushion towards an all-equity portfolio. These are usually all-weather funds as they are considered to be less risky as compared to their equity counterparts and are an alternative to investors keen in holding fixed income instruments.  More liquid than FDs: A debt fund is very liquid—you can withdraw your investments at any time and the money is in your bank account the next day. Unlike a fixed deposit, the fund house does not levy a penalty for exiting too soon. Some funds have an exit load if the investment is redeemed within 3-6 months. You can make partial withdrawals, without having to break the entire investment.  Tax efficient: In the long term, debt funds are far more tax efficient than fixed deposits. After 3 years of investment, the income from a debt fund is treated as a long-term capital gain and is taxed at 20% after indexation. In indexation, the cost of investment is raised to account for inflation for the period the investment is held. The longer you hold a debt fund, the bigger is the indexation benefit. There is also no TDS in debt funds. In fixed deposits, if your interest income exceeds Rs 10,000 a year, the bank will deduct 10.3% from this income. If you are not liable to pay tax, you will have to submit either Form 15H or 15G to escape TDS. The other problem is that the income from fixed deposits is taxed on an annual basis. You may get the money after the deposit matures 5-6 years later but the income is taxed every year. In debt funds, the tax is deferred indefinitely till the investor redeems his units. What's more, the gains from a debt fund can be set off against short-term and long-term capital losses you may have made in other investments.  You don't lose even a day's growth: You don't lose even a day's growth when you invest in an open-ended debt fund. If you invest in a fixed deposit or a closed-ended fixed maturity plan, you get a lump sum amount at the end of the term. In a debt fund, the investment never stops growing till you redeem it.  Your returns can be higher: The pre-tax returns from debt funds are comparable with those from other debt options such as fixed deposits and bonds. But if there are changes in interest rates, your debt fund could give higher returns. The funds that invest in long-term bonds are more sensitive to changes in interest rates. If interest rates decline, the value of the bonds in their portfolio shoots up, leading to capital gains for the investor and vice versa.  They offer greater flexibility: Debt funds are also more flexible than fixed deposits. You can invest small amounts every month by way of an SIP or whenever you have surplus cash. Similarly, you can start an SWP to withdraw a predetermined sum from your investment every month. This is particularly useful for retirees who want a fixed income every month. You can also change the amount of the SWP whenever you want. RETAIL RESEARCH
  18. 18. Changes in the corpus (Rs Crs) of the sub-categories of Income Funds: Only the sub-categories ‘Credit Opportunities’ and ‘Corporate Bonds’ saw growth in their corpus among the categories over periods. Analyst: Dhuraivel Gunasekaran (dhuraivel.gunasekaran@hdfcsec.com) Source NAVIndia, ACEMF & AMC Sites. RETAIL RESEARCH Fax: (022) 3075 3435 Corporate Office: HDFC Securities Limited, I Think Techno Campus, Building –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Fax: (022) 30753435 Website: www.hdfcsec.com Disclaimer: Mutual Funds investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non-Institutional Clients. RETAIL RESEARCH

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