Debt fund investment: Debt fund managers are shunning roll-down strategy, what it means for investors As the maturity date draws nearer, the tenure for which the fund holds bonds reduces (rolls down). Any fresh bond purchases are also aligned with the remaining maturity of the portfolio. To avoid reinvestment risk from the likely fall in interest rates in the near future, several fund managers are shifting to active duration management
Debt funds are likely to do well in the coming few years as interest rates are expected to fall. Fund managers are making necessary tweaks to their portfolios in anticipation of softening yields. Apart from increasing the duration, some are rethinking the pursuit of rolldown strategies in their portfolios.In a roll-down approach, a fund maintains a portfolio of bonds that all mature at the same future date. As the maturity date draws nearer, the tenure for which the fund holds bonds reduces (rolls down). Any fresh bond purchases are also aligned with the remaining maturity of the portfolio. This practice makes returns from a bond portfolio relatively predictable in a volatile interest rate scenario.
It was a particularly sought-after tactic in categories like corporate bond funds and banking & PSU bond funds. Unlike the typical open-ended funds, where the fund manager actively shifts the duration profile of the portfolio as per the given mandate, the passive investing approach of the rolldown strategy provides a degree of predictability in returns amidst interest rate fluctuations.
Fewer funds are opting for roll-down
Average maturity (months)
Note: Above funds only include corporate bond funds & banking PSU debt funds. Compiled by ETIG Database. Source: Ace MFHowever, some fund managers are now looking to pivot away from the roll-down strategy. There’s an emerging consensus that interest rates will start falling at some point this year. This provides potential for substantial capital gains in portfolios with longer durations. Longer duration bonds benefit more from falling interest rates as bond prices and yields are inversely related.
A few funds that have completed the previous roll-down cycle have now shifted to a more active management of duration. The argument is that falling yields will introduce reinvestment risk in portfolios maturing in the next 1-3 years. This risk refers to the possibility that cash flows received from the portfolio, such as coupon payments or maturity proceeds, will have to be reinvested at a much lower rate. So, even if the yield-to-maturity (YTM) of a debt fund holding three-year bonds is currently 7.5%, if interest payouts from the portfolio are reinvested at progressively lower rates, the final return on fund maturity will be lower. On maturity, the fund can only redeploy money at the then prevailing lower rate.
Gautam Kaul, Senior Fund Manager, Fixed Income, Bandhan MF, asserts, “The predictability of return in a roll-down portfolio comes at a cost. It exposes the investor to reinvestment risk as the fund gets closer to maturity. Going forward, the latter is going to be more pronounced than the interest rate risk.” Bandhan Corporate Bond Fund is in the last leg of its four-year roll-down started in early 2020. Going forward, it will be actively managed within a 1-4 year maturity band.
A senior executive from another AMC, who did not wish to be named, observed, “Roll-down has lost a bit of its sheen in the past few years. It is a tactic that is better played via target maturity index funds.
Tightly defined duration limits for actively managed open-ended debt funds also limit the scope for pursuing roll-down.” While a roll-down is easily deployed within a closeended structure, it is trickier to implement in an open-ended format, where there are constant outflows and inflows in a fund. For one, fresh inflows need to be invested in bonds aligned with the remaining maturity of the fund portfolio, without materially impacting its yield. However, finding bonds of odd tenures of, say, two years or six years to match the existing maturity profile of the fund is difficult. Further, a debt fund that faces big outflows much before its target maturity may be forced to redeem its bonds prematurely, possibly at a loss.
However, not everyone is giving up on roll-down in debt funds. Some fund managers continue to believe in its merits. Dhawal Dalal, Head , Fixed Income, Edelweiss Mutual Fund, remarks, “We are sticking to roll-down in our Banking & PSU debt fund. We pursue high duration in this fund, which places it above its peers in the category. Longer-term bonds lock in yields for a longer period, bringing in a level of certainty for the investors.”
Sandeep Yadav, Head, Fixed Income, DSP Mutual Fund, believes in running a rolldown strategy in at least one debt fund at any given time. The fund house runs a roll-down strategy in two of its funds—DSP Savings Fund and DSP Corporate Bond Fund. While the former deploys a one-year roll-down, the latter deploys a three-year roll-down, with the ongoing roll-down ending in 2027. “Not all investors want to go active in duration. They want more predictability in returns,” asserts Yadav. He argues that even if interest rates harden later, incremental flows will be deployed for a short residual maturity, which will limit the hit on the portfolio. He will reassess the roll-down at the end of the current cycle.
The rethinking of roll-down in some debt funds may be a dampener for investors who crave more certainty in returns and are willing to match their investment horizons to the approximate portfolio maturity. For those who don’t want the risk of wrong calls by the fund manager, target maturity funds offer a good alternative for a similar experience.
This story originally appeared on: India Times - Author:Faqs of Insurances
