Last Updated on March 12, 2021 at 10:43 am
In this article, we review a pair of yet another open-ended target maturity index fund: IDFC Gilt 2027 Index Fund and IDFC Gilt 2028 Index Fund. These come hard on the heels of Edelweiss Nifty PSU Bond Plus SDL Index Fund – 2026. It is good to see AMC’s wake up to the benefits of reducing interest rate risk (aka duration risk) by setting a maturity date – an idea we expressed in Nov 2018: Open Letter to AMCs: Why are you not pushing risk-free debt funds enough?
How do open-ended target maturity funds work? Let us consider debt funds that invest only in gilts (central govt bonds) and a little cash. This eliminates discuss of credit rating changes or credit defaults (govt bonds do not have a credit rating for local investments!).
Consider an open-ended gilt fund. The fund manager will continuously buy and sell gilts as per market demand and supply movements to register a capital gain (or loss) in the portfolio. Investors can continuously buy and sell units.
There is no credit risk, but the longer the duration of the bonds held in the portfolio, the higher the interest rate risk aka duration risk. If interest rates increase suddenly (or is expected to be hiked), the demand for existing bonds will decrease and their price will fall. The NAV of the fund holding these would also fall.
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The fall in the price of a 1-month bond would be lower than that in a 10Y bond. This is why liquid funds are less volatile than medium-duration or long-duration funds.
The point that we must focus on here is, in a normal open-ended gilt fund. this interest rate risk will always be present. Giving the funds a target maturity date – after which the fund will stop operations and give the money back to unitholders -effectively eliminates this interest rate risk to unitholders who do not redeem until maturity.
Also, the magnitude of the interest risk decreases with each passing year. Let us consider the two IDFC NFOs as examples:
- IDFC Gilt 2027 Index Fund tracking the CRISIL Gilt 2027 Index matures on June 30th 2027
- IDFC Gilt 2028 Index Fund tracking the CRISIL Gilt 2028 Index matures on April 5th 2028
The current average portfolio maturity of the CRISIL Gilt 2027 (2028) Index is 5.97 years (6.60 years). With each passing year, these nos will decrease. Higher the average portfolio maturity, higher the duration risk, higher the fluctuations in NAV.
By setting a maturity date for an open-ended fund, the duration risk reduces with time and is almost negligible upon maturity. For an investor starting a SIP, the volatility of each sequent instalment will reduce (this does not mean higher returns). The open-ended allows free in and outflow of funds by the investor.
Broadly, the AMCs ideas seem to be the following: Choose 6/7 year G-secs as they have a high yield currently and combine them with T-bills that will be changed every three months. So if the rates increase in future, the newer T-bills will have a higher coupon rate. This is known as a barbell strategy.
- CRISIL Gilt 2027 Index: Yield 6.17%, Avg Maturity 5.97 years
- CRISIL Gilt 2028 Index: Yield: 6.27%, Avg Maturity 6.6 years.
- Both indices will have a mix of 98% 6-7 year gilts and 2% of 91-day treasury bills (T-bills). They will buy and hold these bonds until maturity.
Note: As discussed in the review of Edelweiss Nifty PSU Bond Plus SDL Index Fund – 2026, these are the current yields. Since the fund is open-ended, in and outflows will affect yields along with future interest rates of the T-bills. The NAV will also be significantly volatile in the first few years and then gradually decreasing.
Who can consider investing in IDFC Gilt index funds?
If you do not expect to redeem before the above-mentioned due dates, do not mind the intermittent volatility, you can consider investing some amount in these funds (lump sum/ occasional/periodic investing). However, do not use only these funds for your intended goals.
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