Wealth managers are recommending credit opportunities funds to Indian retail investors to help them negotiate the uncertainty surrounding the direction in interest rates amid talks of a fiscal stimulus aimed at reviving growth.
With the 10-year benchmark yield hardening 22 basis points to 6.63 per cent lately, experts are hunting for funds that are perceived to be relatively immune to rate fluctuations.
To be sure, fund managers believe that a stimulus package of, say, Rs 50,000 crore may not cause an immediate yield surge: Core inflation is in the 4-5 per cent range and is not expected to spike either. This means that bond yields may stabilise at current levels and move in a narrow range.
Credit opportunities or corporate funds essentially invest in corporate bonds and don’t depend on interest rate movements to earn returns, unlike traditional bond funds. These funds primarily generate returns from interest accrual, typically investing in higher yielding but lower-rated (AA or below) corporate bonds.
In addition to earning interest income on the paper held, a fund manager also looks for mismatches in the current rating of a bond compared to its fundamentals. If an upgrade happens in the rating, the bond price will rise, giving a capital appreciation. Fund managers play the accrual strategy in these funds and do not look to earn income from a fall in interest rates.This category of debt mutual funds has seen assets under management rise to Rs 1.03 lakh crore in Aug 2017 compared to Rs 60,000 crore a year back, as investors bet on a corporate recovery and aim to earn higher than fixed deposits and small savings instruments. The category of funds has given a return of 9.1 per cent over the last one year. On the other hand, bank fixed deposits yield anywhere between 6 per cent and 6.75 per cent.
This differential of 200-250 basis points is attracting investors to credit opportunity funds. Baroda Pioneer Credit Opportunities Fund, Franklin India Dynamic Accrual Fund and Aditya Birla SL Corporate Bond Fund have been the top performers, giving returns of 9.5-10 per cent over the last one year.
“After demonetisation, banks have been flush with liquidity and they cut interest rate on deposits, leaving investors with very little choice on investment avenues,” says Nitish Sikand, fund manager, Invesco Mutual Fund. “With declining rates on small savings and bank fixed deposits, lack of opportunities in company deposits and no issuances of tax-free bonds and nonconvertible debentures, fixed income investors are attracted to this category of funds.” “In the next 12-24 months, the GDP is likely to pick up, the economy can improve and we could see some ratings upgrade,” says Kumaresh Ramakrishnan, head (fixed income), DHFL Pramerica Mutual Fund. This is also drawing investors to credit funds.
Given that PSU banks are busy mending their balance sheets and are unwilling to lend more, several corporates are finding it more expedient to raise money through bonds.
“Many banks are unwilling to lend at rates that borrowers want,” says R Sivakumar, head (fixed income), Axis Mutual Fund. “Earlier, there were opportunities only with NBFCs and real estate companies. However, now we are seeing several opportunities from manufacturing corporates tapping the corporate bond market.”
Wealth managers believe investors should keep the risks in mind while investing in such funds as they invest in lower-rated paper that carries default risks.
“The economy is not out of the woods yet. There have been defaults in the past and funds have seen their NAV go down. Hence, investors must put in money with a strong fund house, and invest with a three year view,” says Anup Bhaiya, MD, Money Honey Financial Services, a Mumbai based distributor.