Accrual funds better bet for investors after rate cut

With the Reserve Bank of India (RBI) opting for a 25 basis point rate cut last week, debt fund managers are advising investors to move from duration to accrual funds.

Duration funds make money out of predicting interest rate movements. The higher the duration, the more money the fund will make when interest rates fall.

Accrual funds invest in companies with a lower credit rating, often with an expectation that ratings will improve.

“As we come to the end of the rate cycle, investors should look to increase the yield on the portfolio rather than look at long-duration opportunities. We see value in the short- to medium-term debt funds that invest in papers with a duration of 3-5 years,” said R Sivakumar, head, fixed income, Axis Mutual Fund.

The high-quality AAA-rated papers for a 3-5 year duration are fetching returns of 7 per cent, versus close to 8 per cent for AA-rated papers.

“It is imperative for investors to maintain a bias towards quality, and stick to AA- and AAA-rated papers,” added Sivakumar.

Yields on the benchmark 10year government bonds have slid to 6.44 per cent from 7.16 per cent a year ago.

“While investors in duration funds can continue to hold them, the high double-digit returns seen in the last couple of years may not be sustained. We think income accrual funds should form a larger chunk for investors who want steady, fixed deposit-beating returns from mutual funds,” said Vidya Bala, head, mutual fund research, FundsIndia.com.

Funds relying on duration play had turned cautious and reduced their average maturity after the RBI had a no-rate-cut stance in February 2017. They increased their portfolio maturity in subsequent weeks, anticipating a rate cut. For example, in the dynamic bond fund category, the average maturity of portfolios moved from 7.2 years in February 2017 to 9.9 years by June 2017. Debt fund managers say India’s rate easing cycle is bottoming out, driven by increased risks in the form of fiscal slippages.