Weekly Musings – NFO Pick (Bajaj Finserv Banking and PSU Fund)

30 Oct 2023 , 09:12 AM

WHY LAUNCH A DEBT FUND AT THIS JUNCTURE?

In the latest weekly coverage on mutual fund NFOs, we cover the Bajaj Finserv Banking and PSU Fund. As the name suggests, the Bajaj Finserv Banking and PSU Fund is a pure debt fund, that invests in the bonds issued by Indian banks and other public sector undertakings. Generally, the bonds of PSUs and banks are considered to be moderate to low risk, although the segment has not been a great performer in last few years. Here the big bet that Bajaj Finserv Banking and PSU Fund is making is that the interest rates should peak soon and start to taper gradually. Hence, the best way to play this trend would be to invest in debt instruments issued by banks and PSUs. The idea is to invest in high quality bonds issued by government companies which have a moderate risk profile but lock in higher yields.

The Bajaj Finserv Banking and PSU Fund will be an open ended debt scheme that will invest predominantly in the debt instruments of banks, public sector undertakings (PSUs), public financial institutions. There could be high interest risk but moderate credit risk. The broad view is that after the RBI has hiked repo rates by 250 basis points from 4.00% to 6.50%, it offers a good opportunity to the investors to lock in funds at higher yields. That will ensure interest rate risks work in favour of the fund, even as the default risk is kept low.

WHY IS THE FUND BETTING ON FLAT TO LOWER INTEREST RATES

Investing in bond funds at high yields offers two advantages. Firstly, it allows locking in funds at relatively higher yields. This will ensure higher yield to maturity (YTM). In addition, with falling yields, capital gains will be the icing on the cake as bond prices are inversely related to yields. Here is why the fund expects to bond yields to peak out.

1. CPI Inflation has shown genuine signs of correcting and normalizing. Normally, retail inflation is the biggest driver of bond yields and a series of rate hikes by the RBI has been instrumental in bringing down the inflation. There have been intermittent spikes but that is more cyclical in nature and has been controlled.

    

2. The inflation has been gradually following the RBI dot plot of 4% on a sustainable basis. At 5.02% in the latest month, inflation is now just about 102 bps away from  the target of 4%. At these levels, the chances of bond  yields falling from the current level is very high and that is what the fund plans to lock itself into.

    

3. Globally interest rates are showing signs of peaking out and that trend may spill over to India also. Already, the RBI has not hiked rates since February 2023 and inflation has been largely in control during this period. 

    

4. A major driver of inflation in India has been oil prices. While the price of Brent Crude has risen from $70/bbl to $92/bbl, the fund is of the view that most of the risks, including the geopolitical risks, are already in the price of oil. Hence, any substantial spike in oil prices from current level looks very unlikely. 

    

5. The fund sees an opportunity in the flattening of the yield curve. Today, bonds in the maturity tenure of 3 years and 5 years give equal to or more yield than the 10-year bond. This is a signal of long term uncertainty. From the perspective of the Banking and PSU Fund, this opens up a big opportunity as most of the bonds are in the tenure of 3 years to 5 years and they can earn yields at par with or more than 10 year bonds.

    

6. The fund also sees a time-bound of opportunity since the probability of the 5 year bonds paying more than the 10 year bond is just about 16% if you consider the last 8 years data. So, mean reversion will soon rectify the situation, benefiting the fund.

The intent of the fund is to leverage not only on locking into higher yields, but also to play on the gains from falling yields as well as the mean reversion of yield spreads in the bond market. In addition, the fund is also of the view that with the credit spreads having narrowed, there is greater investment sense in buying high quality bonds issued by banks and PSUs.

Riding the Yield Curve – an integral part of the fund strategy

One of the strategies that the Bajaj Finserv Banking and PSU Fund plans to adopt in this scheme is to ride the yield curve. That is what riding the yield curve entails.

• Riding the yield curve refers to a fixed-income strategy where investors purchase long-term bonds with a maturity date longer than their investment time horizon. For example, a fund with a 3 year maturity buying a 5 year bond.

   

• The fund would then sell their bonds at the end of their time horizon, profiting from the declining yield that occurs over the life of the bond. This would be done with focus on bonds that show high sensitivity to yield shifts. 

   

• This is how the strategy works. The fund with a 3-Yr investment horizon may buy a 5-year bond because it has a higher yield, the investor sells the bond at the 3-year date but profits from higher 5-year yield. They gain from higher yield lock and capital gains. 
   
• If interest rates falls and /or yield curve shape changes to normal from the current flat yield curve shape, then riding the yield curve is considered to be profitable strategy. Otherwise, it may be largely a neutral strategy.

The Bajaj Finserv Banking and PSU Fund NFO is all about would be looking at riding the yield curve for generating alpha on the fund.

How a Banking and PSU Fund typically invests?

Here is how a typical banking and PSU fund is structured in terms of its asset mix.

• The Banking and PSU funds are short to medium term funds that invest in bonds and public sector undertakings (PSUs).

   

• The Banking and PSU funds typically invest about 80% of the corpus in debt instruments issued by banks and public sector undertakings, with leeway for the other 20%.

   

• The assets held by these funds have superior credit quality compared to other debt funds and they further minimize the risk by focusing more on top-rated debt instruments.

   

• Banking and PSU funds also try and focus on maintaining an optimum balance between liquidity, safety, and yield. As explained earlier, riding the yield curve is a popular strategy for these funds.

The general practice of such funds, including the Bajaj Finserv Banking and PSU Fund will be to invest 80% in AAA bonds of banks and PSU companies with the balance 20% invested in either sovereign bonds or other high credit quality bonds.

Why invest in the Bajaj Finserv Banking and PSU Fund NFO

There are several reasons why the Bajaj Finserv Banking and PSU Fund expects to be in a sweet spot at the current juncture. 

• With bond yields already at a high, the probability of yields falling is quite high. From the current levels, if yields fall by 50 bps, the MTM gain will be 1.75% assuming a standard modified duration of 3.5 years. If the yields taper by 100 bps (fairly likely), then the MTM gain at the same MD would be to the tune of 3.50%. Potential to gain is huge. 

   

• With the yield curve flattening, the chances of the mean reversion to an upward sloping yield curve are quite high. That may result in yields on medium maturities falling much faster due to the flat yield curve. That is something the fund hopes to ride on. 

   

• The fund is also betting that the inclusion of the Indian G-Secs in the emerging markets index of JP Morgan would result in FPI flows of nearly $30 billion into Indian debt. This is likely to make the bond markets more robust and liquid.

   

• The yields are at a stage where the potential to make MTM gains are quite high even if one were to assume a modified duration of the portfolio at around 3 to 4 years, which is the norm for such funds. 

   

• Even in the absence of capital gains or MTM gains kicking in, the ability to lock into higher yields itself would be an unbeatable advantage in high quality bonds. 

Who should invest in Bajaj Finserv Banking and PSU Fund NFO

Here are the kind of investors that must be looking at investing in the Bajaj Finserv Banking and PSU Fund NFO.

1. Investors looking to create a foundational portfolio for a short to medium term horizon of around 3 to 5 years.

    

2. Investors look at debt with a higher degree of safety combined with attractive yields on the investment.

    

3. Investors who are willing to look beyond the traditional fixed income options currently available in the market, but focused on quality

    

4. Investors looking at genuinely diversifying their bond portfolio in terms of quality of portfolio, maturity, and ability to ride the yield curve.

Highlights of the Bajaj Finserv Banking and PSU Fund NFO

Here are some key takeaways that investors should know about the NFO.

• The Bajaj Finserv Banking and PSU Fund FNO opens for subscription on October 25, 2023 and closes on November 06, 2023. Nimesh Chandan and Siddharth Chaudhary will be the fund managers. It is an open ended debt fund with no entry and exit loads.

   

• The index performance will be benchmarked to the Nifty Banking and PSU Debt Index and it will look to beat the index by yield curve riding. No returns are guaranteed.

   

• Being a debt fund, the investment objective is to generate income by investing predominantly in debt and money market instruments issued by banks, PSU and PFIs

   

• Lumpsum purchases in the NFO must for a minimum of Rs1,000 and in multiples thereafter.

It marks the return of Banking and PSU fund in the NFO market after a long gap.

Understanding the Banking and PSU Fund universe

Here is a quick look at the other Banking and PSU funds in the market indexed descending on returns since inception.

Scheme  Name	NAV  Direct	1-Year Return (%) Direct	3 Year Return (%) Direct	Launch  Returns	Daily AUM  (Rs in crore)
Aditya Birla Sun Life Banking & PSU Debt Fund	330.96	6.94	4.96	8.46	8,153.21
ICICI Prudential Banking & PSU Debt Fund	29.76	7.45	5.68	8.19	8,298.32
Edelweiss Banking and PSU Debt Fund	22.12	7.07	4.60	8.16	327.25
Kotak Banking and PSU Debt Fund	59.12	6.90	5.08	8.14	6,017.65
HDFC Banking and PSU Debt Fund	20.83	7.03	5.02	7.95	6,429.96
DSP Banking & PSU Debt Fund	21.59	6.68	4.49	7.90	2,549.40
SBI Banking and PSU Fund	2,882.16	7.00	4.45	7.88	4,418.74
Franklin India Banking & PSU Debt Fund	20.48	7.21	4.83	7.83	648.02
Axis Banking & PSU Debt Fund	2,374.94	6.71	4.76	7.80	14,318.96
Bandhan Banking & PSU Debt Fund	22.16	6.84	4.83	7.76	14,586.08
Nippon India Banking & PSU Debt Fund	18.70	7.08	4.90	7.68	5,290.59
HSBC Banking and PSU Debt Fund	22.33	6.81	4.05	7.46	4,485.92
LIC MF Banking & PSU Debt Fund	32.55	6.82	4.42	7.31	1,111.35
Invesco India Banking & PSU Debt Fund	2,102.87	6.63	3.60	7.07	117.29
UTI Banking & PSU Fund	19.45	6.93	6.49	7.06	944.95
Sundaram Banking & PSU Debt Fund	38.05	6.77	4.15	7.06	358.33
Tata Banking & PSU Debt Fund	12.84	6.90	4.82	6.37	249.44
Canara Robeco Banking and PSU Debt Fund	10.67	6.47		5.66	405.61
ITI Banking & PSU Debt Fund	11.66	6.82	5.25	5.25	30.11
TRUSTMF Banking & PSU Debt Fund	1,134.82	7.17		4.73	351.39
Mirae Asset Banking and PSU Debt Fund	11.52	6.60	4.44	4.43	78.40
Baroda BNP Paribas Banking & PSU Bond Fund	11.22	6.72		4.11	29.07

Data Source: AMFI

The Banking and PSU Funds have given returns in the range of 4.11% to 8.46% with median returns around 7.6%, which is fairly good in pre-tax terms. The total AUM of these funds is currently Rs79,200 crore and the latest offering from the Bajaj Finserv Banking and PSU Fund NFO should help enhance this AUM.