ICICI Prudential Long Term Plan: Safe choice for the risk-averse - Buy

After holding rates through four policies, the RBI finally cut the repo rate by 25 basis points last week. But the G-Sec yield, that fell by 70 bps over the past year, has not moved much. It continues to hover in the 6.4-6.5 per cent range. This is because, bond markets have already factored in the rate cut and possibility of further cuts remain uncertain.

While the recent data has forced the RBI’s hands, the central bank continues to retain its neutral stance (it had changed its stance from accommodative to neutral in February this year).

How the monsoon pans out, HRA increase under the Seventh Pay Commission, adverse impact of base effect, and fiscal risks emanating from state farm loan waivers — that can still exert upside pressure on inflation in the second half of this fiscal — leave little headroom for further rate cut.

Given the uncertainty over rates, investors averse to taking risk could consider dynamic bond funds that have the flexibility to switch between short-term and long-term debt instruments.

ICICI Prudential Long Term Plan is one such fund that has dynamically managed duration across rate cycles to deliver category-beating returns across rate cycles and tenures. Over the last three and five years, the fund has delivered 12-12.5 per cent return, outperforming the category by 2-3 percentage points.

The NAV on debt funds rises or falls along with the underlying bond prices. One of the factors that impact bond prices is the interest rate movements in the economy.

If interest rates move up, bond prices fall. This is because investors flock to newer bonds that offer higher rates. This reduces the attractiveness of older bonds and hence their prices decline.

The reverse holds true under a falling rate scenario; bond prices move up. Thus rates and bond prices have an inverse relationship.

This is where ‘duration’ comes into play. As longer duration bonds are more sensitive to interest rates, the fund manager increases duration to cash in on the rally in bonds in a falling rate scenario.

In a rising rate environment, the fund manager reduces the duration of the fund, to cap losses.

Active duration has helped ICICI Prudential Long Term Plan tide over various rate cycles. When the RBI hiked rates abruptly in 2013, the fund managed to deliver a return of 9.6 per cent return that year.

The fund has also made the best of rallies. In the 2014 bond rally, for instance, the fund delivered a strong 19 per cent return, by taking the duration all the way up to seven years.

While retaining a high duration hurt its returns in 2015, the fund managed to beat the category by 3 percentage points in 2016, delivering around 17 per cent return. So far in 2017, the fund has delivered 5.9 per cent return, beating the category’s 4.2 per cent return.

While active calls on duration help the fund manage the rate risk well, investments in mainly high-rated bonds and government securities mitigate the credit risk as well.

Currently (as of June 2017) the fund holds 68 per cent in government securities, 18.6 per cent in AAA rated bonds and 10.6 per cent in AA rated securities. It has a duration of 6.9 years.

This can help it cash in on the rally if bond yields move lower.

Given the RBI’s recent cut and uncertainity over rate action, the fund manager may decide to lower the duration to cap losses.

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