- A short-term debt fund with quality debt instruments
- Well placed to capture higher yields in income accrual space
- Investors with a minimum 2-year period and willing to handle very short-term volatility
In our Debt outlook for 2018, earlier this month, we discussed about the need for an income accrual strategy going forward. At this point in time, we think such a strategy is better executed using short-term debt funds. A sharp rise in yields has provided better accrual opportunities for funds; with some of them buying paper with higher accrual at lower prices. While you can also consider medium-to-long term income funds for this purpose, given the lower maturity with short-term funds, the volatility will tend to be lower in the short-term income space in the current scenario. For example, while the average returns of income funds for the past 3 months were marginally negative, short-term debt funds have managed to keep themselves in positive territory.
In the short-term debt fund space, HDFC Short Term Opportunities has been our core recommendation for those looking for stable returns with quality credit and low duration risk. Close on its heels is another fund, Aditya Birla Sun Life Short Term (ABSL Short Term) Fund. With annualized returns of 9.4% since its inception in 1997, the fund is also among the oldest funds in this category, weathering various debt market cycles.
The fund and suitability
ABSL Short Term is a short-term debt fund suitable for investors with a minimum period of 2 years or more. The fund seeks to invest in high quality debt papers with a view to earn returns from coupon (interest) of the underlying instruments. However, the fund also manages its duration albeit with a band (without moving to very high maturities). To this extent, it is slightly more volatile than HDFC Short Term Opportunities. Investors with a 2-year plus time frame can consider the fund, if they already hold HDFC Short Term Opportunities as their core fund.
With a return of 8.3% and 8.9% annualised over 3 and 5-year periods respectively, ABSL Short Term’s performance may seem better than even HDFC Short Term Opportunities fund. However, where the fund slips, is in volatility. The HDFC fund has a superior risk-adjusted return because of lower volatility (measured by standard deviation). Further, the worst 1-year returns (in the past 3 years) at 6.2% for the HDFC fund is better than the 5.9% return from ABSL. This is a result of higher volatility with the latter fund. A slightly higher duration also means that ABSL can underperform in periods such as the last 3 months of yield rise, when it lagged the HDFC fund.
Having said this, in the last 3 years, when 1-year returns were rolled daily, ABSL Short Term beat the HDFC fund 93% of the times, albeit marginally. That means its slightly more aggressive strategy has delivered well on most occasions. Long story short, if you are willing to overlook the short-term gyrations in this fund, then you can expect it to deliver superior returns over longer periods.
Portfolio & strategy
ABSL Short Term has made quite a few changes to its portfolio, exiting some of the longer dated government papers and instead sticking or consolidating positions in instruments with higher coupons. As a result, its yield to maturity was 7.72% in December 2017, up from 7.1% in October. The fund has quality papers with 55% of its portfolio (December 2017) allocation in AAA-rated and AAA(SO) rated papers and 16% in AA+ rated ones. Three months ago, in the debt market, the spread (yield of bond over gilt) for a AA+ instrument was 69 basis points. Today, the spread for a AAA paper is about 77 basis points. In other words, you get a higher yield for lower risk today. Therefore, we think entering accrual at this stage can be attractive.
As mentioned earlier, the distinguishing strategy of this fund is an active duration strategy within a band. For example, from an average maturity of 3 years in June 2017, the fund reduced this to 2 years now given the sharp up move in yields. In general, the fund operates its average maturity in a band of 2-3 years and tries to accordingly change the nature of instruments – whether to play accrual or duration. Why are we making this point? Because, this is where it fundamentally varies from HDFC Short Term Opportunities. The HDFC fund does not try to actively manage duration, even within a band. It primarily seeks to own top-quality papers to get reasonable accrual income from them. It’s this differentiator, that either causes higher volatility or delivers superior returns for the ABSL fund, compared to its peer.
FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis for investment decisions. To know how to read our weekly fund reviews, please click here.