It has been a picture of stark contrast for debt funds between July and August with investment strategies drawing the line between the winners and the vanquished. If funds with a higher allocation to AA and below rated papers survived the sudden hike in interest rates in July, debt schemes with high exposure to gilts have emerged on top in August as sentiment improved later in the month.
While AA rate papers offer a high coupon, they are low on liquidity and hence, largely insulated from volatility in the event of interest rate fluctuation. On the other hand, high credit quality papers and gilts are more volatile with changing interest rate for their high liquidity.
Consider this. Among four funds, which ended with positive gains in July, three funds had an average exposure of 37 per cent to AA and below rated corporate bonds on July 31. On the other hand, their average investment in gilts was only 9 per cent. With these funds high on credit risk and low on liquidity count, they were absolutely shielded from the July 21 hike in CRR and bank rates and ended with positive return for July 2000. Since the market for even triple A rated bonds is largely illiquid, it is difficult for debt funds to mark-to-market lower graded bonds in the portfolio. Add to it, there is no uniform valuation model for debt funds and a number of them value their holdings internally.
"While illiquidity in corporate bonds and absence of a valuation model is a genuine problem, funds also get some leeway when they value holdings internally,'' said a debt fund manager, who did not wish to be quoted.
Take for instance, Escorts Income Plan, which topped the charts with a 0.56 per cent gain in July 2000 while the average loss for 24 medium term debt funds was 0.25 per cent for the month. While the July holdings of the fund are not available, the August portfolio reveals that the fund has a 54 per cent allocation to AA and below rated corporates while less than 1 per cent holdings are deployed in government securities. However, the fund is a poor 19 among 24 debt funds for August despite an almost identical gain of 0.55 per cent.
On the other hand, funds with a relatively high cash component and investments in gilts have staged a comeback in August. A combination of double-digit call rates interspersed with brief rallies in gilts helped these funds notch up fresh gains. Kothari Pioneer epitomises a complete reversal in fortune of debt funds. This fund was at the bottom of the heap in July with a 0.82 per cent erosion in NAV but has rebounded with a 1.31 per cent gain in August to top the charts. While a nearly 30 per cent allocation to gilts (maturity not available) pulled it down, a combination of high cash component and gilts has seen the fund bounce back.
Yet again, there have been funds, which have remained on top in both the months. This could have been due to a variety of reasons. One, some of these funds have a judicious mix of AA bonds and government securities. While a higher interest income outweighed losses on gilts in July, price appreciation in the latter boosted returns last month. Take for instance, LIC Bond Fund, which has around 40 per cent allocation to AA rated paper and 16 per cent assets in gilts in July. While the fund posted a return of 0.03 per cent return in July (ranked 4), it was also up 0.83 in August (ranked 6).
In the case of funds like Dundee Bond (PSU), it has been deft portfolio management. With 72 per cent of the assets in cash and short-term securities and an average maturity of only 0.49 years, the fund gained 0.39 per cent in July. Given the high repo and call rates in August, the fund has continued to benefit due to a high cash component and ended with a 0.76 per cent gain in August.
The volatility in the last two months has given some insight into an array of investment strategies, being adopted by debt funds. Some funds have been low on credit quality but it has also kept them largely insulated from interest rate gyrations. In the case of few others, a high exposure to gilts has made these funds resemble a bungee jumper - down first but coming back with a vengeance.