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Long duration bond funds are topping 5-year return chart. Is it time to invest?

Long duration bond funds have beaten every other mutual fund category in the five-year horizon.

, ET Online|
Updated: Sep 19, 2019, 11.07 AM IST
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Long duration bond funds have beaten every other mutual fund category in the five-year horizon. These debt schemes have beaten even the mid cap and small cap categories during the same period. Long duration bond funds are offering 9.93 per cent returns in five years, highest return among all the equity and debt mutual fund categories. Small cap schemes have offered 8.94 per cent and mid cap schemes have offered 8.93 per cent returns in the five-year horizon. Should mutual fund investors add these debt schemes to their portfolio?

Most mutual fund managers and advisors do not recommend these schemes to average investors because of the higher volatility associated with these schemes. Mutual fund advisors say most of their clients who invest in debt schemes have a conservative risk profile, and long duration schemes are not meant for them.

“These schemes get impacted the most in the duration curve. You can’t invest in these schemes for two or three years, if you can take volatility and want to generate alpha in these schemes, you should have at least 4-5 years in hand,” says Gaurav Monga, Director, PxG Consultants.

Long duration schemes are extremely sensitive to changes in the interest rate cycle. Fund managers also point out that long duration bond funds were offering negative returns last year when all other debt fund categories were faring better. “My advice is that don’t look at these returns in isolation. These historical returns shouldn’t be your motivation to invest in these schemes. Historically, whenever debt schemes have given great returns in one year, they haven’t replicated it in the next year,” says Pankaj Pathak, senior fund manager, Quantum Mutual Fund.

The rise in crude oil prices will impact these schemes the most, mutual fund managers say. They believe that these schemes are extremely sensitive to the yield movement. In the last one week, when the crude oil inched up and yields also rose to 6.71 per cent, these schemes have given -0.82 per cent returns. “If the crude oil prices go up and sustain between 70-75, we will see the yields moving up which is a bad news for all duration funds, especially the long duration and gilt category,” says Lakshmi Iyer, CIO-Debt and Co-head product, Kotak Mutual Fund.

In the near future, fund managers believe that the RBI might keep rates lower or even cut the rates further. This is good news for the long duration funds. However, experts believe that investors shouldn’t expect another 20 per cent returns from here on. “We have time and again seen that the market hasn’t been able to see where the rates have bottomed. This is a reason why dynamic bond funds couldn’t do great. To believe that you will earn this 20 per cent and get out is not possible. Also, to expect another 20 per cent is being too ambitious. That might not happen, says Pankaj Pathak.

Fund managers believe that if you have the risk appetite and want to generate alpha over a longer investment horizon, these schemes can be a part of your portfolio. “If you can take the volatility and stay for long, these schemes can be a 20-30 per cent of your portfolio, depending on how much volatility you can take. These schemes will give you negative returns also, you have to be aware of that. Most of your debt portfolio should be short to medium duration funds topped up with corporate bond funds and liquid funds,” says Lakshmi Iyer.

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