Short-term Debt Funds: On a Steady Path z

Liquidity, capital preservation and income are short-term debt funds’ basic attributes. In other words, they basically offer you the co...

Liquidity, capital preservation and income are short-term debt funds’ basic attributes. In other words, they basically offer you the comfort of splashing around without much fear of drowning. Compared to its volatile cousin, equity, a bond fund offers more stability, and is a safe investment option.

The reason why I bring them up is that the fund category—short-term debt funds—which I’m about to discuss belongs to this family. The youngest in the family, short-term debt funds offer good yields, but at minimal risk. Those investors who don’t wish to lock in cash for a long duration won’t find a better option than

this. This offering doesn’t have a particularly lengthy track record but in my opinion these ‘extended’ cash funds are of a superior income-earning option to a cash fund for investors with an investible surplus of 3-6 months.

A short-term debt fund usually maintains a small allocation to gilts, higher allocation to medium-tenure corporate bonds and lower cash holding than a cash fund. Thus, over 3-6 months, these funds can deliver 50-60 basis points higher returns, and with greater stability.

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Earlier, investors with a short-term investment horizon of 1-3 months had just two options: a cash fund or a debt fund. If one opted for a cash fund one had to make peace with the fact that returns will be lower, as cash funds maintain a short maturity and a low marked-to-market portfolio to generate steady returns. Alternatively, invest in the more volatile, longer-maturity medium-term debt funds.

Standard Chartered AMC launched the first short-term debt offering, with an investment horizon spreading over 1-6 months. Soon, other AMCs followed suit. Currently, there are 23 such schemes floating around. And, more interestingly, nine schemes have been launched in the last six-months. But remember bond funds come with attendant risks that may catch the uninitiated on the wrong foot. These dangers include interest risk, inflation risk, credit risk and liquidity risk.

When rates rise, bond prices fall. The longer the maturity and the lower the coupon rate the greater the vulnerability. As for inflation, it erodes the value of fixed returns. However, parking cash in high-quality securities can minimise credit and liquidity risks. In a declining interest rate regime short-term debt funds have had a dream run so far. Their performance is surely like to send others (read: cash funds) into a sulky mood.

These funds usually maintain an average maturity in the 0.5-1.5-year range. Thus, they are less vulnerable to changes in the interest rate as compared to medium-term debt funds. Consequently, these funds fetch you lower return than medium-term debt funds would. For instance, during the 50 basis point cut in bank rate (in October), the category’s monthly return stood at 0.82 per cent, as against medium-term debt funds 1.37 per cent return.

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However, the year-to-date return of 8.54% turned in by short-term bond funds is a lot better than the 6.51% return clocked by cash funds, as on December 12, 2002. The category’s 1-month rolling return over the past three months has been a healthy 9.13 per cent.

Based on the superior performance over a rolling basis, the picks among the short-term debt funds include: Tata Bond Short-term Bond Fund Launched in August 2002, this fund’s average maturity has been among the highest in the category. The others are Zurich India High Interest Short-term and HDFC Short-term Fund.

The author is the chief executive of ValueResearch, which tracks mutual funds. He can be reached at dhiren@valueresearchindia.com