Moneycontrol
Last Updated : Apr 17, 2020 10:43 AM IST | Source: Moneycontrol.com

Explained: Why chasing bond yields can be risky

A higher YTM may look attractive. But it can come with higher risks.

All debt funds carry yield-to-maturity (YTM) figures. These numbers indicate the return that fund managers expect to earn from their underlying investments. Although funds are banned from giving indicative yields in public, the month-end portfolio disclosures carry the YTM figures. Deduct fund expenses (total expense ratio) from the YTM and you get the net yield; that’s the investor’s return in hand.

The question is: should you rely on it and make an investment decision?

How accurate is portfolio yield?

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YTM tells you how much returns you can earn from your debt fund, provided it stays invested in all those underlying securities, till maturity. The net yield is the expected return from the portfolio. For example, if a fixed maturity plan’s portfolio yield stands at 6.75 per cent and the expense ratio is 25 basis points, then the net yield to the investor is 6.5 per cent. “This approach is based on the principle that the investor will pocket the yield (or interest income) if the bond is held till maturity,” says Joydeep Sen, founder of wiseinvestor.in. “It gives an indication to the investors on what to expect; however, the real return can be different,” he adds.

Why not chase high yield?

A higher YTM may look attractive. But it can come with higher risks. On December 31, 2018, BOI AXA Credit Risk Fund had a portfolio yield of 13.49 per cent and expense ratio of 1.99 per cent. That worked out to a net yield of 11.5 per cent. But the fund suffered badly, eventually, on account of the credit risks it had taken. The default in some of the bonds held by this scheme resulted in a 45 per cent loss in 2019.

Numerous other examples can be found in credit risk funds. “In case of a default on a bond or downgrade of the credit rating of a bond held in the portfolio, the fund’s net asset value falls, as per the valuation norms,” says Rupesh Bhansali, head-mutual funds, GEPL Capital.

Why actual returns differ?

A drastic change in portfolios can upset the yield that was earlier stated. After the scheme categorization and rationalization norms announced by the capital market regulator Securities Exchange Board of India (SEBI) in October 2018, many schemes changed their characteristics and their underlying portfolios.

A fund that follows the duration strategy can switch between long and short-term bonds. Such changes can alter the fund’s yield drastically. The same holds true even for Banking and PSU bond funds. Interest rate movements can impact your returns too.

In March, bond fund NAVs declined as bond yields went up, caused by the massive selling by foreign investors. “After investing in a bond fund, if the interest rates move up, then the actual returns may differ from the net yield at the time of investing,” Sen adds. If the interest rates fall, then the investors may benefit from it.

Change in expense ratios and frequent inflows or outflows that causes sudden portfolio changes are some of the other reasons that can impact net yields.

What should you do?

Chasing yields is the last thing you should do. In debt funds, the ideal return you should target is 100 to 150 basis points over and above the prevalent inflation rate. A basis point is one-hundredth of a percent point. If a debt fund shows a high YTM, check if it’s taking too much credit risk. A high YTM is not bad if your fund sticks to highly rated instruments.
First Published on Apr 17, 2020 10:43 am
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