Two events have set the stage for a rise in yields, whether the RBI pauses or hikes rates. One, a few weeks ago, the RBI closed the tap that pumped liquidity into the system. That meant no more excess supply of money. This caused an immediate rise in short-term yields, causing mark-to-market losses in some funds over a week or two. In just 2 months, the 3-month government bond moved from 2.9% in December beginning to 3.36% now. This is a sharp move for a shorter tenure bond.
Two, Budget 2021 has decided to retain its market borrowing at Rs 12 lakh crore, same as the pandemic-hit year. It has also provided many novel measures to tap the debt market for infrastructure financing. The 10-year gilt yields climbed sharply as the budget was announced.
We think that the duration gain that longer duration strategies gave is coming to an end. We had proposed a short duration strategy in our 2021 Debt Outlook. Over the next few months, we will cover in detail the short duration funds that we already have in our Prime Funds list, so that you are aware of your choices.
But what about those of you who are holding longer duration funds? Do you sell your longer duration funds and move to a shorter duration? The answer is NO. We’ll explain why at the end of this article.
The fund we’re picking today, to play the shorter duration accrual strategy is HDFC Short Term Debt. This fund has long been a part of Prime Funds.
The fund & suitability
HDFC Short Term Debt is a predominantly accrual-based strategy with some lever to use duration to push returns. Its average portfolio maturity has not exceeded 3.75 years thus far. It is ideal for those with time frame of 2 years and above (no limit on the maximum timeframe needed).
It has less than 10% exposure to papers below AA+. To put this in perspective, if you take the short duration and banking & PSU debt category (which we classify together for our analysis given that they need the same holding period), the average holding in papers below AA+ is 3.5%. Hence, you should be willing to take this above-category average risk (discussed more later) for some additional returns.
HDFC Short Term Debt stands out for its performance, when compared to different categories of funds.
- The fund has beaten the short duration category average 94% of the times based on rolling 1-year return, rolled daily, for 3 years – making it the best in category in terms of consistency.
- If you take a larger universe of short duration and banking & PSU debt funds, it excels still – with a 98% outperformance. Only Axis Short Term matches this consistency.
- For many of you thrilled by the high returns in the floater funds category – a comparison there too shows that the fund’s average 1-year returns (for 3 years of daily rolled periods) was 8.7% compared with an average 7.9% for floater funds with 3 years of data.
- It even keeps pace with HDFC Corporate Bond, which gains more with higher duration. Average 1-year return of 8.7% is not too far from HDFC Corporate Bond’s return of 8.8%!
That’s a bunch of comparisons. So how do you fit this fund in your portfolio? Here’s how to decide:
- If you are risk averse: banking & PSU debt funds of less than 3-year duration and corporate bond funds for over 3-year duration would fit you better.
- If you prefer less volatility and have a time frame of 1-2 years, then the floater funds we recommend would be a better fit. Their volatility (barring the ones with high duration) over 1-month time frames is far lesser than HDFC Short Term Debt.
- If your requirement is higher return for marginally high risk (we call it taking calculated risk), then this fund will fit you.
- If you have a large corpus and add this fund, consider holding a banking & PSU along with it to diversify. If you have a longer time frame, then add it along with a corporate bond fund. If your question is whether you can hold all 3 – you can!
- If you hold other funds from our recommended list and chose them based on your time frame, there is really no need to switch to this fund! Please note this point well 😊 Only if you are looking for diversification or fresh allocation should you consider adding HDFC Short Term Debt. Don’t make a move just because your long-duration fund is suddenly falling now. Please read the section at the end of this article.
HDFC Short Term Debt has been adept in changing its duration within a limited range to provide superior gains to its peers. The chart below will show you how it upped its average maturity to ensure it participated a bit in the rate fall that began from 2019. This appears to be the primary reason for its above-category average returns.
Now, since August, it has been very gradually reducing its maturity to ready itself for a rate hike scenario. It still could not escape the hit in the past 1 month that generated negative returns across many categories. However, going forward, we do expect the fund to bring down maturity and generate accrual. Up until such time, some volatility should be expected.
HDFC Short Term Debt holds over 150 securities and is well-diversified across groups. Government securities, instruments from HDFC, REC, SBI and the Tata group account for over 5% each of its holdings. So, there is little concentration risk.
However, the fund has 8.4% in papers below AA+. A majority of this comes from 3 heads – Tata group companies (3.9%), Vedanta group (2.3%) and perpetual bonds of public sector bonds (but this is low at only 1.2%). The rest comes as micro holdings in names such as Hindalco, Shriram and Mannapuram to name a few.
In other words, the risk too is not concentrated. Of this, our concern at this juncture remains the Vedanta group. However, the proportion held allows us to take the risk, in the absence of any severe redemption pressure. The fund’s size at Rs 17,900 crore also provides the leeway.
This small risk with active duration (within limited range) helps the fund deliver marginally higher returns than the category. Do note that the fund does have a history of dealing with some defaults (Hazaribagh Ranchi Expressway of the IL&FS group) without taking much a hit, because of its well-diversified portfolio.
The fund is managed by Anil Bamboli since its inception in June 2010.
Should you switch your longer duration investment to shorter duration?
We have been receiving queries on whether you should switch from your corporate bond or constant maturity funds to shorter duration funds as most of the duration funds sport 1-month losses of around 0.5%. The answer is NO.
When we provide a strategy, it is to play ‘point in time’ – meaning if you were to deploy additional surplus in the best possible channel now, what that would be. At this juncture, that option would be shorter duration.
However, this does not mean you should disturb or switch your longer duration funds (meant obviously for longer duration). Such a strategy results in 2 things: one, you would lose out on the likely marginally higher returns that longer tenure funds would give you with time. Two, you would unnecessarily incur taxes.
Trust us, the extra returns from accrual compared with the poor returns you will see in all your longer duration funds will be temporary. We have, through many articles, explained to you (one here) that there will be losses when rate cycles turn upward in duration funds. That will start playing out now. It is normal and is not cause for panic. You do not need to act.
If you have fresh money to invest or have some money sitting on the sidelines because rates were low – start deploying. You can do it now or in phases. It does not matter.
If you are choosing our long-term portfolios with corporate bond or constant maturity funds – please invest. Be patient for it to work over 5 years or as stated there. If you cannot take the volatility, then always stick to shorter duration – lower return or not. Keep it simple, either way!