Banking & PSU Debt Funds – Should it form a part of your Core Debt Portfolio?
What does a Debt Investor really want?
In simple words, he wants Safety of Capital, Steady Returns, Liquidity, and a higher post-tax return.
But unfortunately, in the recent past, what has transpired is a series of downgrades,defaults of debt paper and illiquidity in the debt markets which have triggered a series of unfortunate events in a slowing economy, now hit by a lockdown post-Covid 19 which may further worsen the conditions in the short term.
So is all lost and should investors shun Fixed Income or Debt Funds and remain invested in traditional instruments like Bank Fixed Deposits only?
The answer is No -there are some categories of debt funds and many schemes in the mutual fund universe which still offer a high degree of safety
One such category, which has become a hot favorite in the current scenario is the Banking & PSU (Public Sector undertakings) Debt Fund Category.
Banking & PSU Debt Funds Returns & Portfolio Attributes :
|Data as on 31.05.2020||Compounded Annualised % Returns (as on 25th June 2020)||PortfolioAttributes(as on 31.05.2020)|
|Scheme Name||AUM||1 Yr||2 Yrs||3 Yrs||5 Yrs||YTM (Yield) (%)||Average Maturity (Yrs)||Modified Duration|
|Edelweiss Banking & PSU Debt Fund||229.24||14.49||12.60||9.73||9.01||6.82||8.83||6.15|
|IDFC Banking & PSU Debt Fund||16790.54||12.89||11.70||9.35||8.63||5.76||2.82||2.41|
|Nippon India Banking & PSU Debt Fund||4972.81||12.59||11.00||8.67||8.89||5.65||2.98||2.45|
|DSP Banking & PSU Debt Fund||2880.77||12.47||10.80||8.50||8.80||5.23||3.38||2.82|
|L&T Banking and PSU Debt Fund||4029.32||12.20||9.89||8.24||8.35||5.74||2.76||2.38|
|Axis Banking & PSU Debt Fund||15316.70||11.60||10.77||9.16||8.76||5.58||2.20||1.90|
|Aditya Birla SL Banking & PSU Debt Fund||12229.98||11.44||10.47||8.40||9.10||5.97||4.57||3.37|
|SBI Banking and PSU Fund||6230.41||11.44||10.14||8.79||8.51||5.76||3.76||2.97|
|Kotak Banking and PSU Debt Fund||6163.15||11.37||10.71||8.60||8.75||6.40||4.12||3.14|
|Franklin India Banking & PSU Debt Fund||1058.54||11.15||11.05||8.71||8.73||5.14||2.60||2.05|
|PGIM India Banking and PSU Debt Fund||63.20||11.15||10.27||8.18||8.36||5.84||3.67||2.88|
|HDFC Banking and PSU Debt Fund||6031.40||11.12||10.19||8.12||8.66||6.94||3.43||2.67|
|Invesco India Banking & PSU Debt Fund||58.23||10.59||9.58||8.18||7.74||6.20||7.57||5.33|
|LIC MF Banking & PSU Debt Fund||1433.26||10.24||9.99||8.41||7.99||5.50||2.92||2.54|
|Sundaram Banking & PSU Debt Fund||1583.42||10.21||9.84||7.76||7.87||5.01||1.16||1.10|
|ICICI Pru Banking & PSU Debt Fund||10475.81||10.06||9.33||7.42||8.74||6.50||4.76||3.25|
|UTI Banking & PSU Debt Fund||138.77||9.04||4.46||4.73||6.73||5.70||2.93||2.21|
So what are Banking & PSU Debt Funds?
As the name suggests these funds, by mandate, invest 80% or more in bonds and debentures issued by banks and state-owned companies(PSU), which carry a high degree of safety and liquidity. The rest – upto20% can be invested in other securities.
Who should invest in Banking & PSU Debt Funds?
1. Investors having an Ideal Time Horizon of 3 yrs or more :
Most of these Funds hold debt paper of an average maturity from 2-4 years so this is not meant for short term parking. It is ideally suited for an investor who can stay invested for 3 years or more.
2. Investors preferring an alternate to Bank Fixed deposits from a taxation point of view :
Investors who wish to earn a better post-tax yield in comparison to other traditional fixed income instruments and are willing to take a slightly higher risk can consider these funds. If the investors hold these funds for 3 years or more they enjoy LTCG (Long term capital gains) concessional tax rate and indexation benefits from a tax planning point of view.
How does LTCG Tax benefit HNI (High Net-worth) investors vis-à-vis Bank Fixed Deposits (FDs)?
Suppose an investor is in the Highest Tax Bracket and for eg. is getting 5.5% p.a. in a Bank Fixed Deposit and for simplicity sake, we take the same Return in a Debt Fund.
In a Bank Fixed Deposit, his post Tax CAGR (Compounded Annual Growth Rate) return for 3 yrs will be in the range of 3.75% CAGR whereas in a debt fund, with indexation and LTCG benefits he could earn close to 5% CAGR
3. Investors who want a Lower Credit Risk in the Portfolio
Exposure to AAA-rated securities is above 90% for this category and the only 2 categories carrying a much higher % allocation to AAA securities than this category, are Corporate Bond and Gilt Funds (Government Securities). So therefore the margin of safety in Banking & PSU Debt Funds is much higher than in medium duration, dynamic bond, or short-duration funds.There is a very low exposure ( little over 1%) to debt paper having a negative outlook.
Most of the exposure is concentrated in PSU bonds like SIDBI, NABARD, REC, HUDCO, NHAI,etc, or Financial Institutions. The exposure to banks is a lower proportion and has paper-like SBI, HDFC Bank, Axis Bank, ICICI Bank, Canara Bank, Bank of Baroda, etc.
4. Investors who want a High Degree of Liquidity in the Portfolio :
Close to 94% of the assets are liquid or of tradeable nature which is a core factor to be considered in the current scenario – in case of any redemption pressure on the scheme, it is easier for the Fund Manager to liquidate the securities to repay the investors.
5. Roll down strategy: How does it really work?
Close-ended schemes like FMPs (Fixed Maturity plans) and Bharat Bond ETF have a fixed maturity date or a target date when all of the schemes' assets mature and are liquidated to repay investors.
A roll down strategy is somewhat similar to that strategy where the Fund Managers attempt to bring down the maturity profile of the scheme from the initial starting maturity profile to near zero as per the maturity of the papers held by them.
Suppose an average maturity of a scheme is close to 3 years and you have also invested for 3 years then gradually the scheme’s average maturity will reduce in tandem with your investment horizon. Thus interest rate risk (the risk of interest rate or yields moving higher thereby causing a mark to market loss in NAVs) gets reduced closer to the time when you near the completion of 3 years.
Though open-ended schemes cannot have a fixed maturity date nor can the average maturity ever be zero but still some of the Banking and PSU Debt Funds claim to run an active rolldown strategy to bring down the average maturity systematically.
6. Average TER (Total expense ratio) is quite low
The average expense ratio in this category is quite low, as compared to credit risk, medium duration and many of the short term duration schemes which makes them an attractive proposition for investors
Some Key Risk Factors to be considered :
1. Credit Risk
Upto20% exposure in Banking & PSU Debt funds may carry some credit risk as it can be used by the Fund manager to buy higher-yielding paper in order to boost returns including Corporate debt from the private sector NBFCs,lower-rated Housing Finance Companies, smaller banks or even infrastructure-related entities. So, therefore the investor or advisor will have to thoroughly scrutinize the portfolio before committing any investments.
2. Liquidity Risk
Liquidity Risk is simply the risk of not being able to sell the debt paper in the market in case it needs to be sold or in other words whether the debt paper is tradeable to a large extent or not in the debt market on a daily basis.
This risk is largely mitigated if you hold paper which is highly Liquid as most PSU bonds, Gilts (Government securities) and Bank Bonds are by their very nature liquid and mostly the Banking & PSU Debt Funds have such paper in their portfolios.But some of the Funds carry a higher proportion of allocation to below AAA bonds which needs to be scrutinized before committing funds.
3. Interest Rate Risk or mark to market risk
As these portfolios are mark to market they carry volatility or interest rate risk in their portfolios. Suppose the interest rates or yields go up so then the longer duration portfolios suffer a mark to market markdown in the interim. Such a risk is mitigated to a large extent in a roll down strategy followed by some of the mutual funds or having a low average maturity or duration in the scheme.
4. Exposure to AT1 Bonds
The recent Yes Bank AT1 bonds write off demonstrated the fact that even perpetual AT1 bonds of Banks are not really 100% safe. Some of the Banking & PSU debt funds in order to boost yields have a high exposure to AT1 bonds. While AT1 bonds of banks like SBI, ICICI, HDFC seem ok – the interest forego clause and capital write off clause in case of a loss in the Bank does not bode too well for smaller banks and the exposure to such instruments being limited in the portfolio seems to be a necessary pre-condition.
5. Return expectations need to be moderated/lowered:
While the average 1 yr return in this category is close to 10-12% p.a and 3 yr CAGR return is close to 8-9% p.a – the return expectations going forward need to be lowered as the yields on the portfolios were closer to an average of 5.75% at the end of May 2020 and have trended even lower this month.
Though returns are equal to YTM - Expenses - the equation is not so easy as we have to take modified duration, yield movements, trading gains into account, etc.So therefore on a conservative basis post expense return expectation can be moderated from 4.75-5.75 % CAGR from the current yield levels over a 3 yr period along with LTCG tax benefits (for funds with an average maturity of 2-3 yrs). Any return or yield higher than that will carry a higher interest rate risk (average maturity being higher) or higher credit risk (YTM of the scheme being higher than category )
In conclusion –for an investor – having a Banking & PSU Debt Fund as a part of his core debt mutual fund allocation strategy is a must -considering the safety, liquidity, and predictability of returns.
The three largest funds in this category are IDFC Banking & PSU Debt Fund, Axis Banking & PSU Debt Fund, and ABSL Banking & PSU Debt Fund with AUMs well over 12000 crs which tends to work in their favor with a decent track record and high portfolio quality.
In addition – Axis and IDFC have a roll down strategy for investors which increases the predictability of returns and nil AT 1 bond exposure. ABSL Banking & PSU debt fund also has a negligible exposure to AT1 bonds.
SBI Banking & PSU Debt Fund has an AUM of above 6000 crs, decent returns, and portfolio quality is again high.
Nippon India Banking & PSU Debt Fund has an AUM of close to 5000 crs, a decent track record, portfolio quality is high with nil AT1 bond exposure.
DSP Banking & PSU Debt Fund has an AUM of 2800 crs , which is in fact lower than many other funds, but again has a decent track record and a quality portfolio with Nil AT1 Bond exposure.
Edelweiss Banking & PSU Debt Fund has done the best in terms of returns in the 1 yr and 2 yr horizon and also follows a roll down strategy. But a word of caution is warranted here – it is best suited for investors having a longer time horizon as it can be volatile having an average maturity of more than 8 years.The AUM, in relation to the industry, seems tiny at over 200 crs.
Disclaimer: The above article does not constitute a solicitation for investment or cannot be construed as investment advice and is for knowledge purpose only, based on information available in the public domain.
Mutual Fund investments are subject to market risks and past performance is not an indicator of future returns.