Many mutual fund managers are sensing opportunities in credit funds and accrual schemes these days. These fund managers believe that widening spread between the schemes’ YTM and repo rate offer an attractive entry at the moment. They also say based on valuations, sentiments and industry flows, accrual schemes make a good buy at this juncture.

ICICI Prudential Mutual Fund in a note mentions ‘historically we have seen that whenever the spread between YTM and repo rate has been high, accrual schemes have given good risk-adjusted returns to investors. There is good contrarian investing opportunity available for accrual schemes as the elevated yield due to credit concerns provides a good margin of safety.’

How does this spread between YTM of schemes and repo rate work? Let us understand with examples. We have shown it with data of two schemes from ICICI Prudential Mutual Fund. The schemes have been taken only for illustration purposes and this should not be treated as a recommendation. See tables below:

Illustration 1:
Return analysis for ICICI Prudential Credit Risk Fund


Phase 1: July 31, 2013 till Feb 2014

Average YTM 11.30%
Average spread 3.60%
Average repo rate 7.70%

The fund gave an average one-year return of
11.1 per cent in this phase.

Phase 2: June 30, 2015 till October 31, 2016

Average YTM 10.10%
Average spread 3.40%
Average repo rate 6.70%

The fund gave an average one-year return of
9.3 per cent in this phase.

You can see as the scheme gave higher returns in phase 1 when the spread was wider.

READ  What you should do now to avoid a tax surprise next year

Illustration 2: Return Analysis for ICICI Prudential Medium Term Bond Fund


Phase 1: July 31, 2013 till Feb 2014

Average YTM 11.30%
Average spread 3.60%
Average repo rate 7.70%

The fund gave an average one-year return of
12 per cent in this phase.

Phase 2: June 30, 2015 till October 31, 2016

Average YTM 10.10%
Average spread 3.40%
Average repo rate 6.70%

The fund gave an average one-year return of
9.6 per cent in this phase. As in the case of ICICI Prudential Credit Risk Fund, the scheme generated better returns when the spread was wider.

Mutual fund managers believe that when the yields are not going up structurally, prices are unlikely to fall structurally. If rate cuts get transmitted, we can see a significant improvement in the value of your securities. This a great opportunity for investors.

“Absolute interest rates in the markets are higher as compared to the relative repo rate. So, today if you have 2-3 years AAA PSU bonds which are yielding close to 8 per cent though overnight bond is giving around 6 per cent. Normally, this kind of spread only happens in very tight liquidity environment in rising interest rate scenario. The fact that you are getting in a falling interest rate scenario is brilliant opportunity for investors to get deployed,” says R Sivakumar, Head- Fixed Income, Axis Mutual Fund. You don’t have to take long duration. We are talking about 2-3-year kind of bonds in the short term space, he adds.





READ SOURCE

WHAT YOUR THOUGHTS

Please enter your comment!
Please enter your name here