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In Trouble?

The past few quarters have been tough for this fund. However, a quality portfolio should help the fund sail through the tough time

It signed off 2004 in the bottom half of the category, something its investors had never experienced before. As on July 26, 2005, the fund with year to date return of 2.92 per cent, is behind the category average return of 3.24 per cent.

However, we feel HDFC Income is a good fund and that it will be able to tide over this temporary problem. Before we tell you why, let's see what went wrong for the fund.

The trouble started in 2003 when the fund deserted its cautious investing approach and started taking big interest rate bets. Initially, the fund clocked good returns in the mid-year rally. An average maturity of 8.09 years against the category average's 5.77 years backfired in the volatile last quarter of 2003-it gained 0.89 per cent in the fourth quarter against the category average of 1.14 per cent. However, the year's initial gains saved the fund in 2003 when it managed a place in the first quartile of the category.

The fund was not as fortunate in 2004. It maintained an average maturity of 3.02 to 7.2 years and underperformed the category in all the four quarters. For the first time, the fund actually lost money in a calendar year. It also paid a price in terms of assets, which dipped from over Rs 5,474 crore in October 2003 to just Rs 425.88 crore in June 2005.

However, the fund has a category-beating long-term performance record. It maintains a high quality portfolio and deserves a better treatment.

HDFC Income stuck to quality portfolio through 2003, with gilts accounting for an average 55 per cent and the remaining 36 per cent invested in AAA-rated bonds. Sub-AAA bonds are just 2 per cent of the portfolio. However, initially, the fund was not so quality-conscious and held nearly 10-14 per cent in below-AAA bonds till mid-2001. In the recent past, the focus has shifted from gilts to corporate bonds with the former accounting for only 15.42 per cent of the assets. Stress on quality is obvious from the way the fund manages its corporate bond portfolio. AAA papers form over two third of the portfolio, while the fund is yet to invest in below AA+ papers.

If HDFC Income maintains its quality fund management, there's no reason for worry. However, investors should enter this fund for the long-term.