FundsIndia Recommends: Reliance Medium Term Fund

February 14, 2018 . Vidya Bala
  • What: A short-term debt fund with accrual strategy and some credit risk
  • Why: Accrual strategy with marginal credit risk can enhance returns in a hardening rate scenario
  • Who: Suitable for investors with a minimum 2-year time frame and willing to take some risks

Investors with a minimum 2-year time frame and with some risk appetite can consider investing in a short-term debt fund like Reliance Medium Term. Given the present high yield scenario, short-term accrual funds with marginal credit risk hold potential to outperform in the income accrual space. With a 3-year return of 8.1 per cent annually, despite a falling interest scenario witnessed in the past 3 years, funds such as Reliance Medium Term are well placed to capture the upcoming flat to hardening interest scenario. With higher accrual and low duration, the fund can also generate returns with limited volatility.

The fund and its suitability

Reliance Medium Term is a short-term accrual fund with marginally enhanced credit risk compared with funds in the category. This essentially stems from a higher holding of AA instruments. This makes the fund riskier than our core funds in this category such as HDFC Medium Term Opportunities. We think some amount of credit (without excess risk) may be a good strategy to shore up returns in the present scenario of rising yields. The fund’s present 1-year returns of 6.5 per cent are not representative of the fund’s return potential if held for the suggested time frame. The fund’s 1-year returns were hit by a sudden up move in the yields causing prices of traded securities to dip. However, we think this has made the return potential attractive. It is akin to equity turning attractive in a stock market fall.

You will also do well to know that in the event of a bank deposit rate hike, these funds can benefit more than the FDs are they will have access to higher coupon instruments apart from bank certificates of deposits.

For low-risk investors, funds such as HDFC Medium Term Opportunities or Birla Sun Life Short Term that we wrote about recently, remain better options.

Portfolio and performance

Reliance Medium Term is less volatile than many funds in the category simply because of its accrual strategy combined with low average maturity always. The fund does not try to time the debt market based on interest rates. At best, it plays the same by holding AAA-rated instruments but with low residual maturity. In scenarios such as the present one, it tries to increase instruments with higher accrual (AA-rating) and add more certificates of deposits to maintain liquidity and benefit from enhanced deposit rates for institutions.

As of January 2018, the fund held close to 20 per cent of its holdings in instruments with ratings below AA+. That’s higher than the category average of about 10 per cent as of January 2018. However, the instruments below AA+ consisted mostly of AA-rated instruments. That suggests that the fund’s risk profile is not very high. The fund portfolio’s yield to maturity was at 7.9 per cent and the average maturity of the portfolio was at 1.36 years. With the AA+ spread (different between AA+ bond yields and government security yields) at about 100 basis points, we think there is not much need for the fund to take too much exposure below this rating to get superior returns.

Reliance Medium Term has been reasonably steady in terms of the returns it generated. When returns were rolled daily for 1-year periods in the last 3 years, the fund’s worst 1-year return was 6.1 per cent as opposed to category average (in terms of minimum returns) of 5.1 per cent.  Rolling 1-year returns ending January 2018 and the current month, showed the worst 1-year returns as yields moved up drastically. Still, the fund managed better stability by using interest rate swaps to partly hedge some of its instruments. This ensured the fund was not hurt by rising yields.

Amit Tripathi manages the fund. It is to be noted that with AMCs in the process of changing their scheme categories to fit SEBI’s circular on the same, this fund is likely to fit into the ultra-short or low duration category. To this extent, when the change happens, we don’t think there will be any significant impact on the return potential of the scheme.

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis for investment decisions. To know how to read our weekly fund reviews, please click here.

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