Medium term bond funds are open-ended debt funds that lend to quality companies for medium term. The portfolio of medium term bond funds will have Macaulay Duration of 3-4 years. Under adverse conditions, the Macaulay Duration of the portfolio of the scheme can be between one year and four years. Macaulay Duration is the weighted average term to maturity of the cash flows from the bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price.
The maturity of these funds is higher than short duration funds and lower than long duration funds. These funds primarily aim to earn higher returns than inflation as well as bank fixed deposits which are for a similar duration. Typically, the risk of incurring a loss in these funds over the said time frame is low.
Taxation
If the units of this scheme are held for less than 3 years, it will be treated as short-term capital gains and are taxed as per investor’s income slab. If the investment is held for more than 3 years, then the investment will be treated as long-term capital gains and is to be taxed at 20 per cent with indexation benefit. Furthermore, the tax efficiency is likely to be improved when compared to other traditional investment avenues available for the same duration of investment.
Why invest in medium term bond funds now?
The interest rate in the economy is likely to remain low in an attempt to support growth. Furthermore, in order to aid transmission, the RBI also conducted three operation twists in order to bring down the yields at the longer end of the yield curve, which remained elevated despite cutting the benchmark repo rate by 135 bps in the last calendar year. All of these measures are likely to benefit the portfolios with maturity of 2-5 years, an area where medium term bond fund invests in. And one of the funds which have been a consistent performer in this category is ICICI Prudential Medium Term Bond Fund.
Its robust performance over the years has been a result of the fund houses’ strong investment philosophy, robust investment process, strong credit selection process and better risk adjusted returns. The fund practices an investment philosophy which comprises of Safety, Liquidity and Returns (SLR) in that order of priority for managing all of its fixed income schemes.
The portfolio has maintained adequate exposure to high quality papers at all times. Some of the other aspects which has worked well for the fund includes avoidance of concentration risk, Independent Credit evaluation process for securities to be invested in, accrual focus which helps to ensure predictable and consistent returns, no exposure to G-Sec and conservative duration management to reduce interest rate sensitivity.
To avoid any concentration on the liability side, the fund has ensured an investment cap of Rs 100 crore per investor. Further, the portfolio at all times has maintained an adequate mix of highly liquid securities to meet any unforeseen redemption request and monitors partner-wise concentration in the scheme. All of these measures have proven to be significant in managing debt funds. This can be seen through the fact that ICICI Prudential Medium Term Bond Fund did not have exposure to none of the debt papers which went bad over the past 1.5 years. As on January 2020, the fund’s 3-year post-tax rolling return was at 7.8 per cent while the traditional investment avenue’s presented a post-tax return of 5.2 per cent.
To conclude, given the current scenario in the debt market space, it is the medium term bond fund space which has emerged as an attractive investment pocket with ICICI Prudential leading in this space with its well-managed portfolio.
Manoj D. Shankar is coordinator, Religare Broking Ltd.
The opinions expressed in this article are those of the author's and do not purport to reflect the opinions or views of THE WEEK
