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How to read a debt-fund fact sheet

July 01, 2005 10:04 IST

Part I: How to read an MF fact sheet

You are now acquainted with the nuances of equity-oriented fund fact sheets. Fact sheets also provide important information and insight on debt-oriented funds.

Of course, one needs a different perspective altogether while studying debt fund fact sheets. We have outlined some of the significant details that should catch your eye in the fact sheet.

Long-term debt funds

In long-term debt funds there are three areas in the fact sheet that need your attention. Credit rating profile of the debt instruments, the fund's exposure to gilts (government securities) and the average portfolio maturity.

The reason why these areas have been highlighted for special mention is because most of the risks associated with managing the fund stem from these areas.

The credit profile of the debt fund is important as it highlights the credit risks the fund manager is taking. For instance, a high proportion of AAA/ sovereign (indicating highest safety) instruments indicate that the fund is taking the least credit risk.

A lower proportion of AAA/sovereign instruments combined with a lot of AA rated paper indicates that the fund is taking credit risk to enhance returns. AA paper tends to offer higher returns as they are more 'risky.'

Some fund managers invest in AA paper expecting a credit upgrade in future, which leads to appreciation in the price of the paper. Per se taking credit risk is not a bad thing, provided it is in line with the fund manager's mandate.

For instance, Sundaram Bond Saver invests predominantly in AAA paper. But its sibling Sundaram Income Plus has a mandate to invest in AA paper to clock appreciation. So the credit profile of the fund must be seen in line with the investment mandate.

The fund's allocation to gilts is another area that could enhance the risk profile of the fund. If a conventional long-term debt fund has high exposure (above 50 per cent for instance) to gilts, then this could spell trouble for the fund during turbulence in debt markets.

Fund managers like to have gilts in their portfolio because gilts provide liquidity, can be used to modify the portfolio maturity (more on that later) and tend to appreciate more on 'positive economic news'. However, when the gilt allocation assumes alarming proportions then it is a matter of concern. Investors need to note that there is something of a paradox with gilts.

Gilts have the highest credit rating (sovereign), even higher than AAA rated bonds. However, they are subject to above-average interest rate risk as gilt prices are more sensitive to economic news than corporate bonds for instance.

The average maturity of the portfolio underlines the interest rate risk the fund manager is willing to take to clock appreciation. In a turbulent interest rate environment, a relatively higher portfolio maturity is risky as longer-dated paper is more adversely affected during such a scenario.

In a falling interest rate scenario, it is common for debt funds to maintain relatively higher portfolio maturities. Currently we are witnessing an unstable interest rate scenario and portfolio maturities are on the lower side.

Most long-term debt funds do not charge an entry load. However, in many cases a premature exit (within 6 months of investment) is slapped with a contingent exit load. The exit load ranges within 0.25-0.50 per cent of NAV.

Look in the fact sheet for the entry/exit load details. Preference should be given to a well-managed debt fund that waives off entry and exit loads completely.

Short-term debt funds

Short-term debt funds are not meant to take credit risks as capital preservation is the most important objective of the fund and taking a credit risk could work against that. So anything less than AAA/sovereign rated paper in the portfolio is a no-no. Short-term debt fund portfolio maturities are typically in the 1.25 1.50 years range.

While evaluating the fact sheet, the credit profile of the fund and portfolio maturity need to be evaluated closely. Typically, short-term debt funds do not charge an entry and exit load, but you may want to check the fact sheet just to be sure.

Liquid funds

Again like short-term debt funds, liquid funds work at preserving capital and earning a return is secondary. Liquid funds have their net assets spread across short-term corporate bonds, treasury bills, call money and cash.

The portfolio maturity is low often in the 3-4 month range (90-120 days). In effect these are the two most important points for you to mark in the fact sheet - short-term debt paper of the highest credit rating (sovereign/P1+) and portfolio maturity in the 3-4 month range. You can ignore the load details; liquid funds do not charge a load on entry or exit.

Long-term gilt funds

There is really not a lot that you need to look at in the long-term gilt fund fact sheet. The reason is because gilt securities have a topnotch sovereign rating. A portion of gilt fund assets are also invested in treasury bills, which again have the highest credit rating.

So in terms of credit risk, gilt funds are as credit risk free as a fund can get. The all-important detail that needs your attention in the fact sheet is the portfolio maturity. As explained earlier, gilt funds are exposed to higher interest rate risk (vis--vis conventional bond funds).

A high portfolio maturity during a turbulent interest rate scenario can be perilous. While it is difficult to put a finger on what kind of a maturity is comfortable at a point in time, investors should probably see fact sheets of several gilt funds to get an idea of prevailing portfolio maturities across the board.

Short-term gilt funds

Again in a short-term gilt fund fact sheet, the portfolio maturity is critical. Gilt prices are more sensitive (vis--vis corporate bonds) to fluctuations in economic fundamentals. As a result, fund managers tend to keep a lower portfolio maturity (vis--vis short term bond funds) in short-term gilt funds to tone down the risk profile of the fund.

Typically, short-term gilt funds have a portfolio maturity of less than a year and in most cases lower than that of the short-term debt fund from the same fund house.

Like long-term debt funds, most long term gilt funds do not charge an entry load, but an exit within 6 months of investment attracts a contingent load.

Floating rate funds

Reading a long-term floating rate fund fact sheet is relatively uncomplicated. Floating rate funds invest primarily in low-risk floating rate paper of a high credit quality. Even the fixed rate paper in the fund's portfolio is usually of a high credit rating.

This is because floating rate funds attract investors with a low risk appetite so the fund manager avoids credit risk and interest rate risk. The portfolio maturity of a floating rate fund is usually in the 1.25-2.25 year range. Most floating rate funds waive off the entry load, but charge an exit load on exit within 6 months from investment.

Monthly Income Plans (MIPs)

In a monthly income plan (MIP) fact sheet you need to keep a tab on three areas - credit profile of the debt component, debt portfolio maturity and the equity allocation.

MIPs do take on some credit risk by investing in AA/AA-/AA+ paper. This is usually in the 10-20 per cent range with several MIPs. Anything above that level could jeopardise the credit profile of the MIP. In terms of portfolio maturity of the debt component, MIPs are conservative.

Most MIPs have a portfolio maturity on the lower side to steer clear of volatility. On the equity side, MIPs invest to the extent they have been mandated. You are unlikely to find it overshooting the stipulated level, as most MIPs are careful on that front. To know the maximum equity allocation you need to check the investment objective in the fact sheet.

With entry and exit loads, MIPs have a varying structure. Some MIPs waive off entry loads completely, some waive it off upto a certain level of investment, while some others impose an entry load regardless.

Likewise there are different exit loads for varying amounts/investment tenures. The best way to find your way around the entry/exit load structure is to refer to the fact sheet.

This article forms part of Money Simplified -- The definitive guide to Mutual funds. Empowered with this issue, you will be able to exercise better control in planning your mutual fund portfolio. This guide will serve as your definite reference point for mutual funds. Get your FREE copy now! Click here

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Sub: CONFUSED .........................

Dear Sir I am new to finance world so while ready this article i got bemused on : 1) is debt and equity fund are ...

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