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Last couple of years were not so good for debt funds. Will debt funds make a strong comeback from here?
Yields were low in 2020 and 2021 as the RBI cut rates sharply after the onset of the pandemic in 2020. Low yields meant that returns from debt funds were also impacted due to lower accrual. When RBI started hiking rates last year, it further eroded returns as yields rose. Currently, the yields are higher both from a nominal and real perspective. The entire yield curve is above current and expected inflation. With RBI looking to pause interest rate hikes, we believe that the returns from fixed income may improve. The next 2-3 years may be good for fixed income investors owing to higher accrual and potential capital appreciation if yields come down by next year.
Of late, Target Maturity Funds (TMF) have become very popular among fixed income investors. However, majority of inflows has come from institutional investors. Retail contribution is less than 2% in some of the largest TMFs. What are the three things that the industry can do to attract retail money in TMFs?
Debt Funds as a category is largely dominated by institutional investors. In the recent past, the popularity of debt funds like liquid and short term funds is increasing among retail investors. Intermediaries are also recommending these funds to help clients save for building an emergency corpus and meeting short term goals. We believe a lot more needs to be done to educate investors about the importance of debt funds in investors’ overall portfolio. This will help the industry in attracting more retail money into TMFs and other debt funds.
Indian mutual fund industry is dominated by active debt funds like corporate bond funds and banking and PSU funds. In such a scenario, why do you think investors and mutual fund distributors (MFDs) should look at TMFs?
Target maturity funds are open ended funds which follow a passive roll down strategy with a defined maturity date and asset allocation. When interest rates are close to peaking out, passive strategies generally tend to do well. Investors whose investment horizon matches with the scheme maturity may look to invest in TMFs. In an actively managed strategy, the duration can keep changing in line with the fund managers’ outlook on interest rates, which may not be similar to investors’ investment horizon.
What’s the rationale for launching PGIM India CRISIL IBX Gilt Index Apr 2028 Fund at this juncture?
We believe that interest rates are close to peaking out and given the current yields, which are attractive both from a real and nominal perspective, it’s an opportune time to invest into fixed income funds. We believe passive strategies generally tend to do well when interest rates are close to peaking out.
The yield curve is flat with only 15-20 basis points yield difference between the 5-yr and the longer duration segment of the curve. As we expect rates to start coming down from next year onwards, the curve may become steeper and thus the 5-yr segment may look better investment from a risk- reward perspective.
How is PGIM India CRISIL IBX Gilt Index - Apr 2028 Fund different from existing TMFs in the industry?
PGIM India CRISIL IBX Gilt Index - Apr 2028 Fund will invest predominantly in sovereign securities and thus is different from a majority of existing TMFs in terms of its asset allocation. We believe that the current spreads of SDLs and corporate bonds over government securities is much below their median. Thus, we believe the spreads could rise towards their long term median going ahead which may make a case for investing in government securities.
There are many TMFs available in the market. What are three things that MFDs can do to shortlist TMFs for their clients?
We believe the following three filters can help MFDs shortlist TMFs for their clients:
- Match TMF’s maturity profile with investors time horizon
- Map investors risk appetite with the fund’s asset allocation and credit profile
- The stage of the interest rate cycle is critical for entry as we believe passive strategies like TMFs are ideal when interest rates are close to peaking out
