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Post Recategorization - How Debt Oriented Funds Look

If you're a debt fund investor, here's how you should decode the new set of schemes in your portfolio

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SEBI's recent move to recategorize Mutual Fund schemes has created quite a stir within the Mutual Fund investment ecosystem. Not only are clients grappling with the issue of how the various changes have impacted their portfolios; it seems that back end services providers such as registrars and portfolio aggregators are struggling with the new normal too! Short Term Pain notwithstanding, this move is expected to simplify investment decisions in the long run, as funds and their nomenclatures have become a whole lot more transparent and less cryptic. If you're a debt fund investor, here's how you should decode the new set of schemes in your portfolio.

Income Funds no longer exist
"Income Funds" used to be a widely misunderstood category of debt mutual funds, as most unknowing investors bought into them with the expectation of achieving some sort of regular income from them. In reality, "Income Funds" were so named because they relied mainly on the interest income that arose from the bonds in their portfolio, in order to achieve returns. The new categorization has rightfully done away with this category altogether, and most Mutual Fund houses have re-classified their income funds as corporate bond-oriented funds, or short duration debt funds.

"Duration" is now a more clearly defined attribute

Few things have flummoxed debt mutual fund investors as much as the concept of "duration". Duration is a direct measure of rate-sensitivity of a bond portfolio - put simply; the higher the duration, the more the bond portfolio will fluctuate in price in inverse correlation with yields. With the recent re-categorization, SEBI has gone really fine grained in terms of segregating debt funds based on their portfolio duration - presumably, to offer clients a wide range of risk/reward profiles to choose from. The various categories of duration-based funds on offer now are (from low to high risk): overnight funds (1 day), liquid funds (91 days), ultra-short duration (3-6 months), low duration (6-12 months), money market (~ 1 year), short duration (1-3 years), medium duration (3-5 years), medium to long duration (5-7 years) and long duration (> 7 years).

Fund that invest into Corporate Bonds now have three distinct "risk tiers"
Debt Funds that invest predominantly into bonds of companies (that is to say, not government securities), have now been divided into three distinct categories: Corporate Bond Funds (mandated to invest at least 80% into AA+ rated bonds or higher), Credit Risk Funds (mandated to invest at least 65% of their portfolio into bonds that are rated lower than AA), and Banking & PSU Debt Funds (mandated to invest 80% or more of their portfolio into bonds of banks and public-sector undertakings. Of these three categories, Credit Risk Funds have the highest default risk - however, they also have the potential to deliver double-digit returns in rating-upgrade scenarios.

GILT Funds now have two categories
Widely misperceived as risk-free due to the fact that they invest into government securities, G-Sec funds have now been segregated into "Gilt Funds" and "10-Year Constant Maturity Gilt Funds". While the risks associated with the former category would depend purely upon the fund manager's choice of duration, the latter is (surprisingly) a very high-risk category of debt funds! A 10-year average maturity would likely correspond to a modified duration of around 7 years, and so funds falling into this category would be extremely sensitive to changes in yields.


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