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Debt Fund Innovation Continues

Driven by an intensely competitive marketplace, funds are attempting to craft a new kind of funds. And the newest being an extended cash fund and a floating rate bond fund

In a tough market for equities, fund families have focussed on fixed income funds for growth. And with a series of innovations, have succeeded in providing a wide choice to fixed income investors. Today, the risk-averse investor has a wide variety of funds to choose from – Funds for an investment of few days or few months or few years or for a clearly defined term. And being a mutual fund, all this comes with high liquidity and superior tax efficiency. This combined with declining interest rate regime and successive rate cuts, the going could not have been better for them.

Driven by an intensely competitive marketplace and demanding investors, funds are attempting to craft a new kind of debt fund to serve a specific set – the extended cash fund. These funds are pitched as a superior income earning option to a cash fund for investors with an investible surplus for 1-3 month period. This fund can be slotted between medium-term debt fund and a cash fund. This new breed of extended cash fund, with a small allocation to gilt and lower cash holding than a cash fund, are expected to deliver 50-60 basis points higher returns with greater stability. Today investors with surplus cash for 1-3 months either choose a cash fund to settle for lower return, as cash funds maintain a very short maturity profile and a low marked-to-market portfolio to generate steady returns. Or they invest in medium term debt fund, which tends to be more volatile given their longer portfolio maturity.

Currently Standard Chartered Grindlays Super Saver Income – Short-term Plan, Prudential-ICICI Short-term Plan and Birla Sun Life – Birla Bond Plus offer this niche plan, while Pioneer ITI Short-term Income Plan is in pipeline awaiting SEBI approval.

The other innovative debt fund in offing is the Templeton India Floating Rate Bond. With the bond fund returns being guided by the interest rates over the short periods, the floating rate bond instruments iron out the interest rate risk as the coupon rate is reset periodically. Upto 60 per cent of the fund will be invested in floating rate bonds. The fund will of appeal to investors bearish on interest rates, as the floating rate component will negate the interest rate risk of the fixed income component of the portfolio.

Debt Fund Innovations – Key Milestones
December 1994 - JM Mutual launched the first open-end medium-term bond fund, with high liquidity, superior returns than a bank deposit and better tax efficiency.
June 1997 –Birla Sun Life launched the first cash fund (Short-term debt fund) Birla Cash Plus. The cash fund delivered returns and liquidity like a money market fund without the lock-in period applicable.
December 1998 - Kotak Mutual launched K Gilt, the first fund with dedicated investments in government securities.
July 1999 - Alliance Capital launched the first open-end MIP amidst a flurry of UTI's closed-end and assured return MIPs. Armed with liquidity and market-related returns, Alliance MIP challenges the edifice of closed-end MIPs.
October 1999 - Kotak Mutual launched the serial plan or fixed maturity plans to minimise the impact of interest rate volatility. Almost like a closed-end fund with hefty exit load, these funds offer implicit assured returns by matching their redemption with underlying bonds.