Three Debt Funds To Consider Right Now

Over the past year, falling interest rates have forced low risk-taking investors to consider debt mutual funds. In fact, the retail and HNI investments within the overall debt find pie (comprising of liquid, GILT and debt mutual funds) shot up by an impressive 31% in the previous Financial Year.

Despite the vibrant inflows into debt funds in recent times, it rings true that most investors have a below average understanding of how they work. They usually enter debt funds keeping only past returns in mind; this usually works to their disadvantage, as the trend that drove returns for that fund in the tracking period (such as rate cuts or narrowing yield spreads) may in fact have maxed itself out by the time they end up entering these funds. Therefore, for investing into debt funds, one needs to be forward looking and analytical in order to extract an adequate quantum of returns over and above the risk free fixed deposit rate. Here are three debt funds you can consider investing into right now, if you have a time horizon of two to three years and are aiming for relatively low risk, FD beating returns.

ICICI Prudential Banking & PSU Debt Fund
YTM: 7.60%
Modified Duration: 3.83 years
If it's credit risk that you're worried about right now, you need to look no further than ICICI Prudential Banking & PSU Debt Fund. Launched 7 years back in 2010, the fund holds more than 85% in SOV and AAA rated bonds, and has delivered an impressive since inception return of 9.17%.

The fund aims to allocate assets between banking and PSU issuances. Depending on the AMC's short-term view on interest rates, the fund's maturities are managed to ensure stability of returns and avoid mark to market losses. It seeks to keep credit risk low by primarily investing in short maturity high quality instruments. The portfolio is structured to generate optimum accrual return with reduced mark to market volatility.

Given ICICI Prudential's moderately bullish view on interest rates in the short to medium term, the fund now has an average maturity of 5.17 years and a modified duration of 3.83 years, implying that it has scope for generating between 1.5 to 2% capital gains from if rates are reduced by 50 bps or so in the next 2-3 policy meets.

DSP BlackRock Income Opportunities Fund
YTM: 8.90%
Modified Duration: 2.36 years
DSP BlackRock Income Opportunities Fund is well positioned for a range bound yield scenario in the medium term, with a portfolio comprising of relatively high yielding bonds. The fund currently has a YTM of 8.90%, with roughly 73% allocation to AAA and AA rated bonds, lending it a 'moderate' credit profile on average.

DSP BlackRock has a robust risk management team comprising of a credit team, trading team and portfolio managers. The Fund Management Team works closely with an independent Risk & Quantitative Analysis (RQA) team, and this structure provides for robust decision making across credits and rates. This lends a degree of comfort to the fund, despite its than less than perfect credit profile.

Investors looking for a stable, accrual based fund that has the potential to provide FD rates + 200 bps returns over the next 12-24 months could consider investing into DSP BlackRock Income Opportunities Fund.

Reliance Corporate Bond Fund
YTM: 8.24%
Modified Duration: 2.94 years
Reliance Corporate Bond Fund (RCBF) is a pure play on private sector corporate balance sheets, and the alpha generation is through investments where there is potential for meaningful improvement in operational and financial matrices of the underlying companies going forward.

RCBF's strategy automatically leads to the selection of potential 'credit rating upgrade' candidates or spread compression stories. Some of their notable success stories have been PVR Ltd, Adani Transmission Ltd., Reliance Utilities & Power Pvt Ltd. and Nirchem Cement Ltd, among others.

Unlike many other funds in the credit/ corporate bond category which essentially focus more on accruals, RCBF's focus is to invest only in AA- and better rated issuers where the potential for credit upgrades is higher. This helps in the creation of alpha through spread compression.

A relatively new fund, RCBF has already garnered Rs. 6,155 crores of AUM as on date, and has delivered an impressive 11.36% return in the past 12 months. It looks good for the next 12-24 months, too; although one needs to temper down their return expectations compared to the previous 12 month return.