Mutual Funds

ICICI Prudential Medium Term Bond: High risks that come bearing high returns

Radhika Merwin | Updated on October 31, 2018 Published on October 28, 2018

High exposure to riskier, low-rated bonds has helped the fund rake in good returns

The recent mayhem following the IL&FS episode — where the NAV of debt funds holding debt instruments issued by the group took a hit — has rattled investors. But risk-takers seeking higher returns should be prepared to take on some risks that come along with high-yielding bonds. Also, the interim impact on NAV— after the fund writes down the value of the defaulted or downgraded bond — usually irons out over a period of time.

Hence, rather than avoiding such funds altogether, investors should draw lessons from such events and take extra care while investing in these funds. A lower portfolio concentration, consistent track record and risk-return trade-off are some of the factors to consider while investing in funds with a relatively higher credit risk.

ICICI Prudential Medium Term Bond Fund (erstwhile ICICI Prudential Corporate Bond Fund), invests 50-60 per cent in AA and below-rated bonds. The relatively higher exposure to riskier, low-rated bonds has helped the fund rake in above-category returns. Over three- and five-year periods, the fund has delivered 7-8.5 per cent annual returns. The fund’s maximum exposure to a single bond is 3-4 per cent, mitigating credit risk.

The scheme currently carries an attractive yield-to-maturity of 9.7 per cent. Investors with a 2-3-year horizon and a high risk appetite can invest in the fund.

Accrual strategy

Some debt funds capitalise on interest receipts rather than gains from bond prices. This means they earn higher interest by investing in lower-rated (AA+ and below) bonds. Investors willing to take risks that come along with investing in such funds, should consider funds with a long track record of performance and lower concentration risk.

ICICI Prudential Medium Term Bond’s portfolio has leaned towards AA and below-rated bonds. Over the past three years, the fund has maintained 30-40 per cent of its portfolio in AAA and AA+ rated bonds. The remaining has been in lower-rated bonds. While this pegs up the risk, returns have been healthy across periods.

Categorised as a medium-duration fund as per SEBI’s mandate, the scheme should maintain the portfolio Macaulay duration between three and four years. Over the past year, the fund’s average maturity has been 2-4 years. While the RBI did not hike rates in the recent October policy, expectations are high of one or two rate increases in the remaining of the fiscal. Hence, short- and medium-term debt funds that carry lower interest-rate risks are good options at this juncture.

Portfolio

Currently, the fund holds about 32 per cent of its assets in AAA and AA+ rated bonds and about 61 per cent in AA and below. Among the AA and below-rated bonds, the fund has around 4 per cent exposure to JSW Steel, Welspun Renewable Energy and Bioscope Cinemas. Its maximum exposure to other low-rated papers has been capped at 3 per cent. The fund currently has an average maturity of two years.

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