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Guest Column A commentary on debt funds post scheme merger

A commentary on debt funds post scheme merger

Let us understand the impact of SEBI’s circular on scheme merger on key categories of debt funds.
Joydeep Sen Oct 27, 2017

The SEBI circular on categorization and rationalization of mutual fund schemes is set to change the way the Indian mutual fund industry offers their products. It will do away with duplication of fund mandates and lack of clarity in fund objectives.

It is not a sea change as it is more of a rationalization, but the parameters have been defined and there are going to be changes in the way funds are managed. Let us look at the new contours of debt fund management.

There will be 16 categories of funds and an AMC may have only one fund in each category.

Here the duration refers to ‘Macaulay Duration’. Macaulay Duration is somewhat similar to Modified Duration. While Macaulay Duration calculates the weighted average time of maturity before the cash flows on bond starts, modified duration measures the price sensitivity of a bond due to change in the yield to maturity. Typically, Macaulay Duration is marginally higher than Modified Duration.

Long duration fund: The duration of the fund has to be more than 7 years. That means, even if fund manager expects rates to move up, he cannot bring down portfolio maturity to make the fund defensive. Hence, it will be a true long duration fund across market cycles. Investors with high risk appetite and long term horizon can invest in such a fund.  

Dynamic fund: There is no limitation in terms of portfolio maturity or duration. It will invest across duration. The fund manager can increase or decrease the portfolio maturity based on his views on market movement. The strategy of this category of funds remains unchanged.

Gilt fund: This category has been defined in terms of composition only; minimum 80% has to be in gilts. Maturity can be across i.e. the fund manager can play either short or long on the yield curve, depending on his views.

Medium to long duration fund: The duration is defined as 4 to 7 years. So far, this category did not exist in the real sense, only a handful of AMCs have a product that adheres strictly to this definition. Now that it is defined, investors will have a choice in this duration bracket.

Medium duration fund: With a duration of 3 to 4 years, it will be a proper medium duration category.

Short duration fund: Currently, the average maturity in short duration funds ranges between 2 and 4 years. Now the definition is 1 to 3 years i.e. in terms of duration, not maturity. There will not be any short maturity gilt fund but one fund across maturities.

Corporate bond funds: This category has been defined, not in terms of portfolio duration, but portfolio composition. Minimum 80% has to be invested in top rated corporate bonds. Currently, the term is used as a synonym of credit-based funds, which has now been done away with. The portfolio duration is expected to be similar to short duration funds.

Credit risk fund: Interestingly, the term risk has been used and SEBI has stated that terms like Credit Opportunities Fund, High Yield Fund, Credit Advantage and so on cannot be used. Minimum 65% has to be invested in lower rated (below highest rated) instruments. The strategy remains same but the terminology has changed. Portfolio maturity is likely to be manage like a short duration fund.

Conclusion

Investors will have more clarity e.g. what is the duration range of a short duration fund or long duration fund or what is the credit quality of a corporate bond fund. The terminology of credit risk funds will be more appropriate now.

The advisor can now recommend funds with a higher degree of conviction as the AMC cannot tweak fund strategy, they have to remain true to label throughout. Simply put, life becomes easier for distributors with better clarity.

Joydeep Sen is Independent Bond Market Analyst and Author.

The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.

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