After Launching Birla Dividend Yield Plus Birla Sunlife Mutual Fund is planning another innovative product—Birla Bond Index fund. This will be the first foray into bond indexing in the Indian mutual fund industry. However, it's an old concept in US, where there are many such funds.
This fund will track the CRISIL Composite Bond Index but in a slightly different way. Birla Bond Index fund will not purchase all the underlying securities in the index. Instead it will use a sampling technique to determine which securities best represent the index and invest in these. Under this, the fund manager will select a representative sample of securities that will resemble the full target index in terms of key characteristics like duration, credit risk, etc. One reason behind this sampling is that the lot size in the debt market does not enable funds to buy a small number of securities. Small investments will thus be tough to distribute over a number of securities. So by reducing the number of securities it has to buy, smaller inflows can be easily deployed. This is also the reason why the fund has a large minimum investment limit.
But it's important to remember that index funds are not risk-free alternatives to actively managed offerings. For instance, the CRISIL Composite Bond Index also contains low rated corporate bonds such as AA-rated bonds (15 per cent). The index is also re-balanced every month and maintains duration of 2.5-3 years. That apart, all bonds in the index will be affected by shifting interest rates. However, unlike other bond funds, which can vary their portfolio according to the relative attractiveness of different papers this fund will have to stay true to the index. The fund should thus replicate the returns of the index.
Normally index funds have a lower expense ratio than actively managed funds. In debt funds this becomes important as returns do not vary much. A lower expense ratio can make a considerable difference in returns over the long term. Thus according to Morningstar the average US intermediate-term bond fund carries an expense ratio of one per cent. As compared to this Vanguard Total Bond Market Index fund charges 0.22 per cent.
In the trailing 9-months, 66 per cent of the medium-term debt funds—25 out of total 38 funds in the category—have outperformed the CRISIL Composite Bond Index, as on January 17, 2003. So Birla Bond Index fund, can be expected to provide lesser returns than actively managed funds. The silver lining here is that the risk should be less. Birla Bond Index should thus be less volatile than its actively managed counterparts.
Birla Bond Index would be a perfect choice for conservative investors who prefer lower volatility. Finally, if the fund's return can come close to matching the performance of the index, it should be a success.
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