Structured mutual fund debt schemes that promise to fetch
higher returns than plain-vanilla fixed income products are finding many takers
among affluent investors and companies nowadays.
These schemes simultaneously invest in banks' one-year certificate of deposits (CD) and high-yield corporate bonds with 15- to 18-month maturity to gain the edge over basic debt products. Fund managers of these schemes, as part of this strategy, lock in a significant portion - about 70%- of the investment portfolio in one-year CDs and the remaining in corporate bonds, including non-convertible debentures.
In this strategy, the CD investments help the fund manager lock-in a higher yield similar to a fixed maturity plan, while the corporate bonds drive the additional returns. At current rates, the investment in one-year CDs could yield as high as 10%. The year when the CD matures, the portion invested in corporate bonds, with 15-18-month maturity, would still carry a residual maturity of 3-5 months.
This is where the fund managers look to cash in. Yields on corporate bonds tend to fall (and prices rise) as the securities near maturity; bond prices and yields move in opposite direction. As bond prices rise, fund managers redeem them, enabling them to gain from the upsides.
"Investors should ideally have one year investment horizon for these schemes. This strategy over one year generally cannot go negative even in the worst case scenario," said Sunil Jhaveri, chairman of MSJ Capital , a firm specialising in fund research and advisory.
"Investors have been tired of taking interest rate and duration calls on debt schemes. Products like FMPs or bank fixed deposits are good, but investors lose out on liquidity and prospects of capital gains."
Templeton India Short Term Plan, Pramerica Treasury Advantage Fund and BNP Paribas Bond Fund have adopted this strategy. Investors hope to pocket 10.5-11.25% returns on such structured portfolios.
"Structured short-term open-ended debt funds are for investors who want to gain from higher short-term rates marked at different (type of) debt papers and tenures," says Mahendra Jajoo , CIO, fixed income, Pramerica Mutual Fund .
"Such type of funds are open-ended in nature. They allow investors the flexibility to restructure investments in the wake of direct tax code roll-out next year," Jajoo said.
The government is likely to take away indexation tax benefits from investors under the new DTC rules. Under the current tax regime, if investors buy a 370-day FMP in March, 2011, s/he is eligible to claim benefits of inflation for two years before calculating the capital gains tax liability.
The fund is structured on the premise that short-term rates will decline in a year's time. In the event of an inverted yield curve (that is when long-term debt instruments have a lower yield than short term debt instruments of the same credit quality), returns on these funds could fall marginally.
Fund managers claim that they have a back-up plan if the existing strategy for this scheme goes wrong. "We'll be able to realign even if our call on interest rates go a bit out of place. In case the rates go up in the interim, we'll replace the existing constant portfolio with higher-yielding securities. This, in a way, will enhance portfolios returns after one year," Jajoo said.
These schemes simultaneously invest in banks' one-year certificate of deposits (CD) and high-yield corporate bonds with 15- to 18-month maturity to gain the edge over basic debt products. Fund managers of these schemes, as part of this strategy, lock in a significant portion - about 70%- of the investment portfolio in one-year CDs and the remaining in corporate bonds, including non-convertible debentures.
In this strategy, the CD investments help the fund manager lock-in a higher yield similar to a fixed maturity plan, while the corporate bonds drive the additional returns. At current rates, the investment in one-year CDs could yield as high as 10%. The year when the CD matures, the portion invested in corporate bonds, with 15-18-month maturity, would still carry a residual maturity of 3-5 months.
This is where the fund managers look to cash in. Yields on corporate bonds tend to fall (and prices rise) as the securities near maturity; bond prices and yields move in opposite direction. As bond prices rise, fund managers redeem them, enabling them to gain from the upsides.
"Investors should ideally have one year investment horizon for these schemes. This strategy over one year generally cannot go negative even in the worst case scenario," said Sunil Jhaveri, chairman of MSJ Capital , a firm specialising in fund research and advisory.
"Investors have been tired of taking interest rate and duration calls on debt schemes. Products like FMPs or bank fixed deposits are good, but investors lose out on liquidity and prospects of capital gains."
Templeton India Short Term Plan, Pramerica Treasury Advantage Fund and BNP Paribas Bond Fund have adopted this strategy. Investors hope to pocket 10.5-11.25% returns on such structured portfolios.
"Structured short-term open-ended debt funds are for investors who want to gain from higher short-term rates marked at different (type of) debt papers and tenures," says Mahendra Jajoo , CIO, fixed income, Pramerica Mutual Fund .
"Such type of funds are open-ended in nature. They allow investors the flexibility to restructure investments in the wake of direct tax code roll-out next year," Jajoo said.
The government is likely to take away indexation tax benefits from investors under the new DTC rules. Under the current tax regime, if investors buy a 370-day FMP in March, 2011, s/he is eligible to claim benefits of inflation for two years before calculating the capital gains tax liability.
The fund is structured on the premise that short-term rates will decline in a year's time. In the event of an inverted yield curve (that is when long-term debt instruments have a lower yield than short term debt instruments of the same credit quality), returns on these funds could fall marginally.
Fund managers claim that they have a back-up plan if the existing strategy for this scheme goes wrong. "We'll be able to realign even if our call on interest rates go a bit out of place. In case the rates go up in the interim, we'll replace the existing constant portfolio with higher-yielding securities. This, in a way, will enhance portfolios returns after one year," Jajoo said.
