Debt mutual funds are not easy products to understand. The moment a bond can be traded in the middle of a tenure, the risk associated with it are often not obvious. Regular readers would be aware that I have discussed this at length. To compound matters further, it is very hard to spot mutual fund that is style pure.
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That is, they do not have a well-defined investment strategy. Most funds (with the exception of pure gilt funds) can invest in several types of bonds with a wide range of maturities. This changes from time to time depending on interest rates. Unfortunately, this means the associated risk keeps changing.
An equity fund investor can rest at ease assuming that the risk is uniformly high. This is not the case for a debt fund investor. They will need to periodically keep an eye on the average portfolio maturity, modified duration and credit rating of the bonds in the portfolio. This is an annoyance.
For more information about these terms, you could download the Free E-book: A Beginner’s Guide To Investing in Debt Mutual Funds.
In a recent post, Anirban Ghosh documented how he selected his first style mutual fund and chose IDFC Banking Debt Fund as a style pure ultra short term fund.
Unfortunately, less than two weeks later, IDFC Mutual Fund has announced a big change in the investing strategy of the fund. Here are some screenshots from the announcement
The current modified duration of the CRISIL Short Term Bond Fund Index is about 2Y. So I think it is safe to assume that the IDFC fund is no longer an ultra short term fund. Perhaps we can peg it as a short term income fund.
It is important to recognise that an AAA rate bond of 1-month duration is not the same as an AAA bond of 1Y duration. Longer the duration of the bond, the more sensitive it will be to interest rate risks. Also, a credit rating downgrade could affect longer bonds more than shorter bonds.
Such changes in the “fundamental attribute” of a mutual fund entitle investors to exit without load, within a stipulated date. But that is cold comfort.
As we mourn the death of an easy to grasp investment strategy (see Anirban’s post above), it is important to recognise why debt funds have this tendency to prefer a broad investment universe in terms of bond category and duration.
The root cause of this problem is us – the investors who chase after returns, take star ratings seriously and do not worry about risks until it strikes. This makes fund houses take excessive risks to stay in contention.
Moral of the story: Keep an eye on your debt fund!
Kolkata DIY Investor Workshop May 28th, 2017
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