Review of 5 medium duration funds

By Morningstar |  16-02-21 | 

Medium duration funds are open ended schemes that invest in debt and money market instruments such that the Macaulay duration of the portfolio is between 3 years – 4 years. Macaulay Duration is the time/number of years it takes for investors to recoup the price of the bond paid in terms of interest payments and principal.

Over a one year period, this category has delivered 0.72% due to a few funds delivering negative returns. SBI Magnum Medium Duration Fund has delivered the highest return (8.93%) over one year period while Nippon India Strategic Debt Fund has lost - 24.01% during the same period due to its exposure to Yes Bank debt paper. This category also houses Franklin Income Opportunities Fund which was wound up by the fund house last year due to liquidity constraints.

Since April 2020, the category has received net inflows worth Rs 1,562 crore. This indicates that investors are not so keen on investing in this category at this juncture due to the exposure to credit which faced defaults and downgrades in the recent past.

Compared to short duration funds, medium duration funds invest in relatively longer tenor securities which benefit from higher term spread. However, the higher duration also entails relatively higher interest rate risk/sensitivity. In an adverse scenario, these funds can lower their duration to one year.

Here is an analysis of five funds from this category.

HDFC Medium Term Debt Plan

  • Star Rating: 5 stars
  • Analyst Rating: Neutral
  • Inception Date: February 2002
  • Return: 7.47% (1 year), 7.96% CAGR (3 year), 8.16% CAGR (5 year), 7.98% CAGR (since inception)
  • Fund Manager: Shobhit Mehrotra and Anand Laddha
  • Average Credit Quality: AA
  • Date of Analysis: December 2020
  • Analyst: Himanshu Srivastava
  • Fund Overview

Manager Shobhit Mehrotra seeks to add value through security selection rather than taking duration bets; the duration is typically maintained within a thin band. Expectedly, the investment approach relies on fundamental research. It entails combining qualitative aspects with quantitative analysis. The investment team prepares the coverage list with a strong focus on the company management and track record, financial strength of the promoter group, and corporate governance standards. Meetings with management are followed by rigorous quantitative analysis in which the focus is to get a measure of the company’s creditworthiness.

The team studies the company’s cash flow and relevant ratios-- leverage, coverage, and solvency. At this step, the team also draws on the expertise of its counterparts in the equity team. The fund company uses a proprietary model in which qualitative and quantitative inputs are used to arrive at a credit score for each issuer. This in turn helps managers determine the exposure they can take to each issuer, thereby acting as a risk-management tool.

Kotak Medium Term

  • Star Rating: 4 stars
  • Analyst Rating: Neutral
  • Inception Date: March 2014
  • Return: 5.46% (1 year), 6.53% CAGR (3 year), 7.40% CAGR (5 year), 8.19% CAGR (since inception)
  • Fund Manager: Deepak Agrawal
  • Average Credit Quality: AA
  • Date of Analysis: December 2020
  • Analyst: Nehal Meshram
  • Fund Overview

The fund house has a fairly tight structure in place to evaluate the credit matrix and take a transaction-based approach while deciding on investments. The fund maintains duration of 3.0-4.0 years and invests primarily in good quality high-yielding assets. The manager seeks to identify duration bets through macroeconomic factors by incorporating views of internal and external economists. Credit analysis is divided into banking, Non-Banking Financial Company, or NBFC, and manufacturing debt, then further demarcated into three buckets based on business strength, management, and corporate governance standards. Surveillance has shot up after the recent spate of downgrades, and now NBFC and Housing Finance Company, or HFC, which was evaluated on a quarterly basis, is now tracked monthly.

The team also keeps a check on the sponsor debt and evaluates asset liability profiles on a monthly basis. The team leverages the expertise of the equity team at Kotak AMC and Kotak Bank. It is then followed by rigourous quantitative analysis, wherein key financial ratios are considered. Deepak Agrawal follows a proprietary model to determine the exposure limit, and the risk-management team ensures the limits are being adhered to.

ICICI Prudential Medium Term Bond Fund      

  • Star Rating: 5 stars
  • Analyst Rating: Neutral
  • Inception Date: September 2004
  • Return: 8.07% (1 year), 8.00% CAGR (3 year), 8.16% CAGR (5 year), 7.66% CAGR (since inception)
  • Fund Manager: Manish Banthia and Shadab Rizvi
  • Average Credit Quality: AA
  • Date of Analysis: November 2020
  • Analyst: Himanshu Srivastava
  • Fund Overview

Over the years, the investment team has not only maintained the efficacy of the investment processes but has also worked towards improving them. Here, Manish Banthia emphasises security selection and portfolio construction over making substantial adjustments to the duration on a regular basis. The team prefers investing in stable companies having higher certainty of returns than targeting uncertain higher returns. The focus is on investing in companies that have strong management teams with proven track records, the financial strength of the promoter group, and good corporate governance standards. This is followed by rigorous quantitative analysis in which various financial ratios are considered. A credit is added in the investment list only after getting approval from the board and risk management team.

Another defining aspect of the investment process is the team’s preference for safety over outsize return. The idea is to focus on achieving long-term sustainable and consistent performance rather than chasing short-term trends. Duration calls are taken after considering macroeconomic factors such as gross domestic product, inflation, and RBI borrowings. Broadly, the investment process is well-defined, robust, and research-driven. 

IDFC Bond Fund - Medium Term Plan

  • Star Rating: 4 stars
  • Analyst Rating: Bronze
  • Inception Date: July 2003
  • Return: 7.51% (1 year), 8.27% CAGR (3 year), 7.91% CAGR (5 year), 7.64% CAGR (since inception)
  • Fund Manager: Suyash Choudhary
  • Average Credit Quality: AAA
  • Date of Analysis: July 2020
  • Analyst: Himanshu Srivastava
  • Fund Overview

Safety, liquidity, and fundamental research are the hallmarks of the strategy plied here. The strategy is structured in a way to ensure that investors are not exposed to unwarranted risks. The fund is a part of medium duration category, where the investment mandate is to maintain the fund's duration between three and four years. Additionally, investments are made only in AAA rated and highly liquid corporate bonds or government securities. Hence, neither the credit nor active duration bets are part of the investment approach. 

For investments in corporate bonds, the team lays a lot of emphasis on the promoter group, its track record, and corporate governance standards. Suyash Choudhary will not lend to a company facing corporate governance issues. Additionally, he also looks at companies' competitive standing with regard to peers, its practices, cash flows, liquidity profile, business and financial risks among others. The strategy of not taking credit risk differentiates it within the category, where several peers adopt a credit-oriented investment approach. In effect, this strategy is apt for investors who don't have an appetite for credit risk.

Aditya Birla Sun Life Medium Term Plan

  • Star Rating: 3 stars
  • Analyst Rating: Neutral
  • Inception Date: March 2009
  • Return: 7.00% (1 year), 2.88% CAGR (3 year), 5.29% CAGR (5 year), 7.51% CAGR (since inception)
  • Fund Manager: Mohit Sharma and Sunaina da Cunha
  • Average Credit Quality: BB
  • Date of Analysis: May 2020
  • Analyst: Kavitha Krishnan
  • Fund Overview

The fund’s core strategy lies in its ability to go down the credit curve to generate alpha. The fund’s mandate is a free-flowing one with the manager typically running a duration between two and four years.

The fund’s focus lies in taking active credit bets. The team’s ability to evaluate credits and invest across credit buckets with a view to optimise returns is important, especially given that the fund invests a significant portion of its assets in sub AA+ rated papers. It allocates a small portion of its assets to government securities. Hence, a combination of duration bets and credit calls drives the fund’s strategy. 

The fixed-income team could take structural, cyclical, or tactical views. They track headline indicators and tend to follow a market-linked strategy as opposed to a pure macro-based strategy that looks at an event after occurrence. On the corporate bond side, the fund house uses internal ratings as opposed to relying on external credit ratings. Any credit can be invested into, only after it makes a grade on the internal research process and is backed by strong covenants.

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