MC30 Fund Pick: A debt mutual fund that acts as a buffer to your long-term equity portfolio

Favourable environment

After a tepid performance in 2022, the debt mutual fund categories have started to deliver better returns over the last 15-18 months, thanks to the central bank’s decision to hold the rates unchanged after the series of rate hikes.

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The expectations of interest rate cuts have kept debt funds in a good position. “Inflation is trending lower everywhere, in India and the rest of the world. Further, external sector looks quite comfortable and stable, and the current account deficit may be well contained. Third is that the growth has started showing a bit of slowdown in some high frequency indicators,” Devang Shah, the head of Fixed Income at Axis Mutual Fund, says.

Experts anticipate that the RBI will likely initiate rate cuts in the next six to 12 months down the line. Already there are expectation that the US Fed may start cutting rates from September itself. “We anticipate that we may see rate cuts from the RBI in the next six to 12 months of up to 0.50 percent,” adds Shah.

Bond prices and interest rates have an inverse relationship, so when interest rates fall, bond prices go up. This results in appreciation of the bonds value that the debt funds hold which, in turn, lead to higher returns.

Well-positioned to gain from the rate cut expectation

Thanks to its moderate duration strategy, ASTF is in a good position to gain from anticipated rate cuts.

Also see: How long-term holding mitigates interest-rate risk and ensures higher returns in debt funds

ASTF invests in debt securities in such a way that the entire portfolio’s Macaulay duration (weighted average term to the maturity of the cash flows from a bond) remains 1-3 years. Short-duration funds are likely to deliver relatively better returns across rate cycles, thanks to their combined investment strategies of accruals and short to moderate duration calls. In a falling rate environment, its duration play helps to generate income from capital appreciation.

Consistent performance

ASTF has been consistent on delivering above-average returns. Mostly, it was either a Quartile 1 or Quartile 2 performer within the category in the past. Fund manager’s active duration strategy helped to deliver better returns across periods.

Performance, as measured by the five-year rolling return calculated from the last seven years’ NAV data, shows that ASTF generated a compounded annualised growth rate (CAGR) of 7.3 percent, while the category gave 6.6 percent (category average was calculated after excluding the schemes that were hit badly by distressed assets).

ASTF has generated a category beaten return in most of the interest rate cycles seen over the last seven years. For instance, during the rising rate in 2022, ASTF delivered 3.5 percent while the category posted 3.1 percent.

A well-rounded portfolio

ASTF holds quality scrips with good credit ratings. Over the last three years, it has increased allocation to the government securities.

Expecting a cut in interest rates, the scheme’s duration is at the upper end of its boundaries, due to what Shah describes as favourable macro-economic environment, lower inflation and reasonable growth. Additionally, positive demand-supply for bonds is leading to a rally in bond market yields.

ASTF has about 28 percent allocation towards the government bonds as of August 2024.

Other than miniscule exposure to Dewan Housing Finance Corporation (during the 2019 bond fiasco), the portfolio has consistently been clean. And ASTF recovered its dues from the company. It has nil exposure to AT1 bonds. The scheme has held about 12 percent in the non-AAA-rated papers from AA segments.

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