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The Mutual Fund Show: Why Crisil Thinks Debt Funds Performed Better Amid Rising Yields

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Volatility in the markets and concerns surrounding payment defaults at the IL&FS group left debt mutual fund investors worrying about their money.

This not only impacted the performance and portfolio of debt funds—generally considered safer than equity schemes—but also their rankings. As of September, Crisil ranked 462 funds based on factors such as performance, duration, exposure to sensitive sectors, concentration of individual issuer and asset quality, among others. Of the total funds ranked, 200 are equity, 214 are debt and 48 are hybrid. Among debt funds, L&T Mutual Fund topped the CRISIL Mutual Fund Ranking. Axis Mutual Fund was ranked second.

This comes at a time when bond prices fell and 10-year yield rose to 8.02 percent in the September quarter, tracking higher crude oil prices and a weaker rupee. Yet, debt funds in all categories offered positive returns in the July-September period. That, Crisil said, may be because fund managers reduced the modified duration of their funds.

The duration strategy, according to Crisil, worked well for ICICI Prudential Corporate Bond Fund that ranked first in its category. But DSP Credit Risk Fund and Tata Corporate Bond Fund fell to third and fifth positions, respectively.

In the second part of the interaction with Crisil on BloombergQuint’s weekly series The Mutual Fund Show, director Bhushan Kedar talks about how they ranked the debt funds.

Watch the full episode here:

Also Read: The Mutual Fund Show: This Asset Manager Topped Crisil’s Ranking And How…

Here are the edited excerpts from the conversation:

The number one fund in rankings is L&T Banking and PSU Debt Fund. It climbed a notch. What is working for this fund?

Bhushan Kedar: It is a concentrated category. The stock will be either picked from banking or PSU sectors. You have the luxury of picking up money market instruments from that specific segment. You are running a concentrated portfolio at a sector specific level.

This fund has outperformed in this period. The interest rates have moved this year where you have seen hardening of 40 basis points on government securities. The fund has taken a conscious call of moving from a relatively high duration to low duration. At the beginning of the year, they were managing at a duration of two. They have now moved to 0.3 which is a significant shift from where they were earlier, one that has really helped them protect the downside and hence show relatively superior performance compared to its peers. That is a key contributor to overall performance if you look at their overall three-month return which is 6 basis points more than its peers and the one-year return is 60 basis points higher.

Even on other parameters, be it exposure to sensitive sectors, the modified duration and liquidity. All the parameters they feature either in one or two ranks that we have at a parametric level. They got it right across all parameters and that’s what made them shift to rank one.

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For Axis Banking and PSU debt fund, one-year return looks robust but it slipped a notch. Why would that be the case?

Kedar: They have taken exactly a reverse call of what L&T has done. They are the ones who have started with 0.6 duration at the beginning of the year and from there they moved to 2.8. So, if you are running a modified duration of 6 months, then 10-year paper will have a modified duration of 6. If there is 100 basis points in interest rates, which means if interest rates are up by 1 percent, then your portfolio value or price of the bond will erode by Rs 6. On a 2.8 modified duration portfolio, 1 percent change will mean Rs 2.8 erosion or a gain.

The other factor that comes in because of running a higher maturity is that the volatility is higher because the mark-to-mark component also goes up. It leads to higher volatility. That is where they have fallen a bit. Not that their rank has slipped significantly. The difference between one and two is much lower.

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DSP Banking and PSU Debt Fund climbed a notch from No. 3 to No. 2.

Kedar: They too ran a very similar strategy as we saw with L&T where in modified duration have been brought down. They have not brought it down as sharply as the L&T Fund, but they are able to bring to 1.12 compared to 2+ duration that they were maintaining. It is the one which gave 20-basis-point alpha over the peer set on a 3-month period. Their one-year return is marginally lesser than peers as of today.

Franklin India Credit Risk Fund became No. 1 fund in a category which was talk of the town among others. What has worked for them?

Kedar: The credit risk as a category in India, the funds do not manage very high duration. Typically, it would be in a 2.5-5 years maturity which they operate in. There is no appetite for going in long-term duration in the credit call. These are hand-pick credits and bottom-up evaluation approaches.

What is important in this portfolio is how one benefits if the credit call they have taken were to be upgraded. You have single A moving to double A or triple A moving to single A. That gives you an upside and performance. The second important bit is the carry you have in your portfolio. You lock-in high coupon generating paper. That carry comes to you every month.

Templeton papers had a carry of anything between 11.5 percent and 12.25 percent. These were some of high yielding papers like Hinduja Leyland Finance and DLF. Hinduja Leyland was upgraded in the recent quarter by a notch which also helped them get 80 basis points on that paper.

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The name which slipped to fifth rank from third rank is DSP Credit Risk Fund. What happened?

Kedar: There will be some of minor factors but let’s focus on the biggest one which is their exposure to IL&FS subsidiaries. Both IL&FS Transportation and IL&FS Energy Development moved to the D-category or the non-investment grade. The energy development moved to non-investment grade and eventually moved to default category. When a paper moves to non-investment grade, AMCs value those papers in house instead of taking from external valuing agency. It is the policy which they had or AMFI in general follows. The haircut ranges from 25 percent to 50-70 percent. On a day, you are knocking down that paper from Rs 100 to Rs 75. That puts tremendous pressure on net asset value. If you have high exposure, things get worse. That is what happened with those specific funds. On the day, when they moved to non-investment grade, they had to take significant hit for their portfolio performance.

ICICI Prudential Corporate Bond Fund is the No. 1 ranked fund and it has climbed two notches. What is the special thing which they did?

Kedar: They played the duration game right. They were able to lower their duration to 1.18 as compared to the category of 1.9. They increased their exposure to gilt securities which was about 13 percent. You do not run credit call with gilt category but for typically gilt securities you tend to have higher maturity. If you see fund managers having gilt purely to play the duration game, they believe that interest rates will soften, they will go bullish on it and they will go into longer maturities. That is where they play the game. They have realised that interest rates are hardening, they got rid of it and moved to lower maturity segment. That is one thing which helped them improve their performance and bring their rank up. Though marginally their asset quality could have got affected in this bargain, but performance covered up for that during this quarter.

The Kotak Corporate Bond Fund has exposure to sensitive sectors unlike most of the funds in these categories. Is that the reason why it lost the No. 1 ranking?

Kedar: We set sector exposures, but it is not the sectoral concentration but sensitive sectors. There is a list of sensitive sectors which are identified by us every quarter. Today, we have names like real estate, civil construction, steel, telecom or some of the specific sectors within telecom. Those are the sectors which get covered today. Kotak Bond Fund had exposure to construction as a sector class. That is where they got little penalised and it brought their rank down by a notch. Besides, they had some illiquid exposures.

Tata Corporate Bond Fund has ranked No. 5, one-year return is 2.86 percent. Something went wrong for it. What is it?

Kedar: They had an exposure to IL&FS. What we understand from the data disclosures is that they have taken a 50 percent haircut. That is really a NAV hit that you land up taking. That has led to 3-month return to negative 1 percent compared to positive 1.09 percent of peers.

How is it that the SBI Magnum Income Fund having some stellar returns on one-year basis slipped two notches?

Kedar: We have a holistic approach. The performance that they have delivered on one-year period is better than the peers. The 9-month performance is little lower than Reliance Income Fund. They have increased the exposure to AA segment. This is the only fund which has 48 percent exposure to AA below segment. That gives them better performance. But you are running the risk of going down on asset quality parameter. When we have asset quality, lower is the rating and higher is the penalty. To come up the rank we need higher spread which results in far superior mean return. The exposure to lower rated segment didn’t quite compensate for delta earned. That lead to the lower ranking.

How Reliance Income Fund managed to do so well?

Kedar: The asset quality is one of the key drivers. They had 18-20 percent receivable in the turbulent environment which we see has protected the downside. You get the normal carry that you get otherwise if you are sitting on a collateralised borrowing and lending obligation or small CD exposure, you will continue to get carry. It can be 2 basis points on a daily basis. You don’t have downside of losing any capital because of interest rate rising. That is the key reason which helped them manage this. Duration has come down a little and helped them protect the rank or improve.

L&T Liquid Fund has stayed as No. 1 fund. They are doing something right.

Kedar: L&T Fund has been featuring in many categories and they are doing well. They have got interest rates right or may be the credit calls right. It is featuring at No. 1 or 2 across all categories. With regards to performance, they have generated 30 basis points extra compared to peers in the last three months. Even when you look at 1-year return, they have generated 30-35 basis points compared to peers. They are being able to manage performance as well as portfolio construct well.

Franklin India Fund has climbed a number of notches from No. 5 to 2. What are they doing right?

Kedar: They were lagging behind earlier on some of the exposure that they were having on the sensitive side. They managed to get out of the sensitive exposures that they had during the earlier quarter. They also had over exposure to some of the issuers like NABARD, Chennai Petroleum and Mahindra Financial Services which they have been able to bring it down at a portfolio level. It helped them improve their ranks in terms of asset quality. At the same time, the fund performance has not slipped. The performance in the last three-month period is equal to L&T Liquid fund. Even the one-year performance is very similar to L&T Fund. The performance was never the challenge and it is only the portfolio attributes which is bringing them down. They have bridged the gap and hence shot up the rank.

Indiabulls Liquid Fund has slipped a bit and is at No. 3. Is it because of exposure to some sensitive sectors?

Kedar: Yes. They were running sensitive exposure to steel, real estate and civil construction. These were some of the sectors to which they had significant exposure compared to their peers which was a drag on their portfolio. Their returns too have slipped. There has been some deterioration in asset quality that we observed during this period. To name some, Nabha Power, South Indian Bank, Sterling Wilson led to a drop in the fund’s asset quality parameter. The performance too slipped. All this put together brought the rank from 1 to 3.

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