Small Wonders? | Value Research These two income funds got a lucky break last year and produced some 'supernatural' returns. Small size worked to their advantage

Small Wonders?

These two income funds got a lucky break last year and produced some 'supernatural' returns. Small size worked to their advantage

Pru ICICI Income Long Term
1-yr Return as on April 26, 2005: 10.22%
Assets on March 31, 05: 1.32 crore

Prudential ICICI Income Long Term has seen ups and downs in the past seven months. Literally! In August 2004, its assets were a respectable Rs 223.81 crore. The next month, the fund size shrank to a meagre Rs 9 lakh as the fund closed its dividend plan.

Does it make sense to run such a small fund for an asset management company? Most of us would think not. But Prudential ICICI continued with the fund, and if the returns are anything to go by, then this fund has been in top gear in recent months. With category beating six-monthly trailing returns of 9.8 per cent in March 2005, it can even challenge some of the equity funds, which went through booming stock markets during the period.

What adds to the amazement is that the fund managed such exceptional returns in spite of being in cash and money market instruments for all the months since October 2004 as per month-end portfolios. Fund manager Nilesh Shah's take on this: "The performance of this fund from October 2004 has got enhanced mainly due to the trading income. The small size of the fund allows the fund manager to take trading calls. The returns have been achieved by active management of portfolio duration. Clearly, this strategy is suitable only for small-sized funds."

However, like all good things, the good returns of this fund have come at a price. 'Trading' has led to the fund becoming more volatile. The fund delivered negative returns of 3.02 per cent in a single day on January 5, 2005. This was followed by positive returns of 3.14 per cent the very next day. There have been other instances of wild fluctuations in the one-day returns of the fund.

According to the stated objective of the fund, it can invest only up to 10 per cent of its corpus in cash and money market instruments. However, this limit has been breached for the last five months in the month-end portfolios. Nilesh Shah explains, "The offer document allows the fund manager to take a defensive position by changing the asset allocation profile. The portfolio manager is seeking to generate returns through active management of the duration of the fund for which it is important to be in cash or near cash assets. For this purpose, the cash and money market instruments investment limit is changed."

Despite the fantastic returns delivered by Prudential ICICI Long Term Plan, it may attract only those investors who have faith in the trading abilities of the fund manager.

Libra Bond
1-yr Return as on April 26, 2005: 9.58%
Assets on March 31, 05: 0.66 crore

When we first noticed the 2004 returns of Libra Bond Fund, we were taken aback-the fund had outperformed the category average returns by a huge margin. It had raced to deliver a whopping 11.60 per cent as compared to the category average return of a meagre 0.90 per cent. This run was surprising because Libra Bond has a long history of underperformance-except for 2004, the fund has always found a place in the bottom quartile of the category.

Interestingly, the fund managed extraordinary returns in a year that proved to be disastrous for income funds not only in terms of returns but also in terms of assets-as the medium term debt fund category was reduced to Rs 6,196 crore in 2004 end from Rs 36,550 crore in 2003.

Anyway, we tried to crack this mystery and discovered some interesting facts.

Libra Bond Fund was up 0.89 per cent in 2004 till November 30. However, in December it sprinted to a phenomenal 10.61 per cent gain and finally ended the year as the best performing income fund.

We asked Taurus Mutual Fund's Vice President C. M. Mathur how did the fund managed such returns. He explained: "We were holding bonds of HUDCO in the Libra Bond Fund. In the fourth week of December, we received heavy redemption requests. In order to create liquidity to meet the redemption, we had to sell the bonds. In terms of SEBI's regulations, these bonds were being valued using Crisil Bond Valuer. However, when we sold these bonds in the market, we were able to get a much better price than the rate at which they were being valued. Due to the fall in the unit capital and the increase in profit on sale, there was a sharp increase in the NAV." This abnormal situation resulted in the NAV jumping by 6.56 per cent on the last day of 2004!

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