NFO: UTI Credit Oportunities – going beyond the interest rate game

A number of debt funds currently bet on the declining interest rate movement, hoping to capitalise on a rally in the price of debt instruments when their yields fall. But what do you do beyond that, when interest rates stabilise ?

UTI Mutual has come out with a new fund on its debt block – UTI Credit Opportunities – seeking to play the debt game, beyond the interest rate cycle.

Profile and strategy

UTI Credit Opportunities will seek to invest in debt and money market instruments to generate income as well as capital gain opportunities. It will do this by investing in instruments with varying maturities and credit ratings. Varying maturities can mean investing in instruments that may have a maturity of less than one year or even five years based on whether interest rates are rising or falling. The fund’s average portfolio maturity, though, would be not over eight years.

A number of debt funds follow the above strategy. But UTI Credit Opportunities will go a step beyond and also try to capitalise on credit spreads. What does this mean? An instrument may have high yields because it is perceived to be riskier than its peers. That means the interest rate differential (called the spread) is higher than a government bond of similar maturity. It will therefore receive a modest credit rating from a credit rating agency. But what if this credit profile is mispriced because of concerns over the sector or a particular segment or because of certain events and they correct after a while?

Take the case of the Tata Motors-JLR deal. The former’s credit rating for its debt was very modest as the JLR deal was perceived to be risky. But the company’s fundamentals ensured that its performance was sound. Or a sector like infrastructure may see a temporary dip in performance as a result of macro issues and then pick up later.

Typically, when such risk perception lowers, the spread (between the seemingly risk instrument and a government bond) declines. In other words, the yields of these instruments fall as they no longer require a high risk premium. When yields fall, the price of such instruments rally – triggering capital appreciation for the holder.

These are the kind of opportunities that UTI Credit will seek to tap. But they are not the only ones. The fund will seek to hold 60-65 per cent in financially sound AAA and AA rated instruments, 20-25 per cent in money market instruments for liquidity and 5-15 per cent in instruments below AA rating on a steady state basis. But this could vary based on opportunities.  According to its offer document it can invest up to 50 per cent of its assets in instruments with rating below AA.

Suitability

What does all this mean to you? Simply put, UTI Credit Opportunities is not for the usual bank deposit investor. It is more suitable for an aggressive and active investor with a long-term holding. Why? The fund will bet on instruments with modest credit rating hoping such credit profile will improve, providing a price rally in its holding. But what if it does not? The fund will seek to reduce this risk through a buy and hold strategy. If its bet does not provide capital appreciation, holding a high-yielding instrument till maturity will at least yield high income (interest).  But that means the fund is meant to be held for a longer period, if you wish to reap the benefit of such high yield.

Also, an element of risk exists because of any possible default by the issuer. According to rating agency CRISIL, the possibility of default of a single-A-rated instrument (at the end of third year) was less than 2 per cent in FY-11. That means a low default risk.

Currently, few funds such as Templeton India Corporate Bond Opportunities and UTI Dynamic Bond do use this strategy but do not invest in instruments below AA. That leaves UTI Credit Opportunities to explore an investment universe less tapped by its peers. The fund will be managed by seasoned fund manager Amandeep Chopra. NFO closes on November 8.