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Should short-term debt funds have a cap on maturity?

LiveMint logoLiveMint 20-02-2017 Kayezad E. Adajania

Lakshmi Iyer, CIO (debt), head-products, Kotak Mahindra AMC

One can’t compare apple with custard apple just because there is a common name ‘apple’ between them. Likewise, a scheme having the words ‘short term’ in its name but without any defined contours, is not appropriate to be compared with another fund with its relevant contours. Hence, there has to be a standardized definition of what construes ‘short term’. It is also imperative from a risk profiling perspective, that the investor knows exactly what she is getting into.

Every fixed income category offers an indicative investment tenure, which acts as a goal post for investors with the correct measure of risk in mind. Imagine going to Chennai and asking for sarson da saag and going to Chandigarh and asking for garlic rasam. In fact, it should be the reverse. Similarly, an investor who comes into a short-term (fund) would want limited-duration exposure. Also, investors should be sensitized to the fact that all debt funds don’t come with a uniform amount of risk. The so-called risk bucketing is prevalent within the fixed income asset class as well. Some are less risky and others are riskier, comparatively. This can be achieved only when, among other things, different debt funds stay and work within their limits.

So, I do endorse the view that there should be a defined contour for most categories in fixed income, including short-term funds.

Sujoy Das, head-fixed income, Invesco Asset Management (India) Ltd

The duration management of short-term funds should be left with the mutual fund managers. Yield movements in the market are a result of diverse views of market participants in a free-trade environment. This helps in transparency of market prices and pricing power of both the issuer and lender. The market always opens up opportunities in various facets, depending upon the altering shape of the yield curve.

The fund managers should retain the flexibility in portfolio strategy as per their reading of the market. This flexibility always helps in altering the portfolio positioning with changing market dynamics and would endeavour to create alpha. A regulated cap on the average maturity of the short-term funds can give rise to several idiosyncrasies and make the market imperfect in this dynamic environment.

Irrespective of the macro fundamentals and liquidity, market movement might be in a different direction and give rise to unsustainable price movements. Price volumes might become scanty or bloated and channelize imperfect allocation of investments. Funds are created as per market position and give rise to healthy trading, liquidity and price discovery. This enables fund managers to read the market closely based on the fundamentals and create alpha for the investors.

Suyash Choudhary, head-fixed income, IDFC AMC

Short-term funds are broadly intended to run conservative maturities and provide some stability to overall portfolio returns of fixed income investors; under normal circumstances. Thus, a conservative investor may decide that more gets allocated to short-term funds, thereby keeping the overall volatility in returns somewhat contained. Another investor may decide to take exposure to duration and/or credit risk, to add the prospect of additional returns to the portfolio; with accompanying prospect of additional volatility. A more aggressive investor may reduce the component of short-term funds and increase allocation to duration and/or credit, due to more tolerance for higher volatility.

Thus, in most cases, the allocation to short-term funds should be meant to deliver a moderate risk-reward profile; whereas the investor overlays additional duration and credit risk on this core portfolio in accordance with individual risk appetite. To that extent, the mandates for short-term funds need to be more tightly defined. Of course, there should be some flexibility to move in line with the fund manager’s view. But the upper band for maturity needs to reflect the intended purpose of the product, while the stated fully active duration funds, including dynamic bond funds, may be used to capture the range of the fund manager’s view.

R. Sivakumar, head-fixed income, Axis AMC

It is important to align the fund’s investment mandate with investor expectation. Investors expect short-term funds to provide exposure to the short-term debt market. Short-term bonds are less sensitive to macro-economic factors such as inflation and global events. Their yields depend largely on the RBI’s policy rate and liquidity.... Normally, short-term bonds would be those with maturities of up to 5 years. A diversified portfolio of such bonds would have a weighted average duration of below 3 years. If a fund specifies an upper limit of 3 years average duration, this is a signal that it’s a short-term fund. Having a low duration would reduce losses in case of a sharp up move in rates, as seen, for example, following the recent RBI policy. A target duration profile could also be achieved with a mix of money market instruments and longer-term bonds (above 5 years to maturity). As the long bond component behaves differently to short-dated instruments, such a fund cannot be said to provide exposure to short-term debt. Funds should specify that they intend to invest substantially, 80% or more, in debt securities below 5 years to maturity. Having an overall average maturity or duration limit, along with a limit on exposure above 5 years, would clearly specify both asset class (short-term bonds) and the risk profile (weighted average duration below 3 years).

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