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Opt for load(ed) bond funds

Fleeing short-term investors in a no-load fund can mar your returns in a falling market

The recent bout of losses in bond funds has once again highlighted the issue of loads in mutual funds. The bull-run in the bond markets had encouraged asset management companies to do away with loads from their debt schemes to encourage short-term or hot inflows. However, with bond funds taking a hit in the last few days, some of the no-load schemes came under redemption pressure. Reason - short-term investors, who had invested in these funds for a quick return, wanted to pull out as NAVs plunged.

In fact, all no-load funds (barring JM Income) lost more than the average fall of 1.35 per cent on Monday. While there is no clinching evidence to prove this trend, it is possible that these fund managers had offloaded a part of their holdings in a jittery market in anticipation of some redemption.

While debt funds typically do not have an entry load, they impose an exit load or a contingent deferred sales charge (CDSC). The latter is linked to your stay in the fund.

Impacts Long-term Investors
While bond markets are stable now with a calmer rupee, Fed rate cut and RBI's buyback, short-term investors are surely on the edge of their seats. Thus, a fresh wave of bear spell could see these speculators again running for cover. However, redemption pressure in such a scenario impacts long-term investors as funds are forced to offload bonds in a falling market. Since liquidity almost instantly dries up, as happened this week, funds under redemption pressure have no choice but to go for distress sales to generate cash. Thus, panic selling translates into losses and hit net asset value. In sellers' market, quotes are few and far between and on occasions, could differ by as much as Rs 1-Rs 1.5.

Further, any late recovery is of little help as the fund has already sold a part of its portfolio. On the other hand, funds with exit loads have an effective deterrent and hardly face redemption. As returns from bond funds come at a painstakingly slow pace, a load of even 0.5% in a declining market could significantly pull down total returns. Two, since these funds are not selling, they only suffer a notional loss and can recoup once the sentiment revives.

Cash of No Avail
While no-load funds may talk about a large cash component to take care of redemption, it is also a drain on the NAV. Reason - In a jittery market, cash cushions the fall in NAV. If the fund were to utilise cash/money market holdings to fund repurchase, the NAV is bound to see a sharper fall.

What Should Investors Do
Investors hate load since they end up spending a part of their savings, sometimes even before the saving begins its work. While avoiding entry and exit load is good for investors, CDSC on most occasions is not bad for long-term investors. It acts as a deterrent to hot inflows when the going is good and contributes to the stability of a fund in turbulent times. Investors, who put money into a fund only to pull it out too soon, can wreck havoc with the performance and impact the returns for dedicated investors. Thus, if you are a committed investor, invest in a bond fund with a contingent deferred sales charge.