Without going to extremes, Principal Income Fund gets the job done for investors. It is not that the fund is conservative on managing interest rate risk or credit risk, but it tends to be exhibit discipline while taking a call on any of them. No wonder the fund has always carried a below average risk profile and an average returns profile. A combination of low-risk and high-returns makes it an ideal choice.
Principal Income Fund's launch in October 2000 couldn't have come at a better time as interest rates had started their southward journey. With concentrated bets in interest rate-sensitive government securities, the fund made handsome gains during the two rate cuts in early 2001. This performance was repeated whenever interest rates fell, for instance during November 2000 to December 2001 and May 2002 to January 2003. During market rallies it may not have posted supernormal returns like some other funds as it has rarely stretched out too far on portfolio maturity.
At the same time during a downslide, investors in this fund have been less vulnerable to losses compared to others in the category. On smelling a volatile situation, Principal Income tends to build a cash pile-up to minimise the erosion in value. So, whether it was the sudden spurt in interest rates in December 2001 or May 2002, Principal Income Fund lost less than its average peer did. But the fund couldn't help losing more than its average peer during the turmoil of early 2003. Nonetheless on volatile occasions after that, the fund has actively realigned its portfolio towards lower average maturity.
As spreads between corporate bonds and gilts have come down, the portfolio allocation has increased in favour of gilts. Within corporate bonds, the low rated corporate bonds, which run a risk of default, have been weeded out. The fund's exposure to these issues has come down from an average 11 per cent in 2002 to 7 per cent in the year 2003 so far. The top rated corporate bonds continue to account for 30-34 per cent of the fund's assets.
Being relatively new in the its category, Principal Income has climbed the performance ladder quite diligently. But keep in mind that its expense ratio happens to be little higher than an average income fund.