Fund Call. IDFC Government Securities Fund – Short Term Plan: For a steady stream of returns: Buy

After holding rates through four policies, the RBI cut the repo rate by 25 basis points in August. Interestingly though, the G-Sec yield, after having fallen by about 70 bps over the past year until then, has inched up by 20 bps since August. There are many reasons for the stickiness in yields. One, despite cutting policy rate, the RBI retained its neutral stance in August, indicating the possibility of inflation moving up in coming months.

After hitting a low of 1.46 per cent in June, CPI inflation moved up to 2.36 per cent in July. In August, CPI inflation went up further to 3.36 per cent, driven by a surge in food prices. The recent inflation trend leaves little headroom for further rate cuts. Monsoons, 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, are also likely to keep the RBI cautious on future rate actions. With no near-term trigger in sight, bond yields have remained sticky.

Given the uncertainty over rates, investors can invest in IDFC Government Securities Fund – Short Term Plan (IDFC G-Sec STP), to ride the volatility. The fund’s modified duration, on an average, has ranged between one and around 3.5 years over the past three years. This mitigates the interest rate risk. Conservative investors with 12 to 18 months’ horizon can invest in this fund for steady returns.

The fund predominantly invests in government securities and hence does not carry any credit risk (of default). This holds relevance in the current market, given the spate of sudden defaults and downgrades that impacted returns of many debt funds, playing the credit opportunities theme — investing in high-yield, low-rated bonds.

The fund is also relatively less risky than long-duration gilt funds. This is because longer-duration bonds are more sensitive to interest rates. Short-term gilt funds may thus deliver lower returns in a falling rate cycle compared to long-term gilt funds. But they are a good choice in times of volatility.

IDFC G-Sec STP has been a consistent performer, delivering good returns across rate cycles. In the 2014 bond rally, for instance, long-term gilt funds delivered robust returns of 16-18 per cent.

Though lower, the fund’s 12.6 per cent return during the period is noteworthy.

The fund upped its modified duration to the higher end of its band to 3-3.5 years to make the best of the rally. In the lacklustre 2015 market too, the fund managed to deliver a healthy 9 per cent return.

Over the past year, the fund has raked in 9 per cent gains, around 100 bps above category average.

The fund invests in a mix of government bonds, state development loans (SDLs), treasury bills and cash management bills. The fund currently has a modified duration of 2.3 years. While not aggressive, this leaves ample scope for cashing in on any interim fall in interest rates.

The fund has a yield-to-maturity of 6.7 per cent — implying that is the bare minimum an investor can earn from the fund if the debt securities are held till maturity.

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