Weekly Musings – NFO Pick (Bandhan Long Duration Fund)

20 Mar 2024 , 11:57 PM

WHAT ARE LONG DURATION FUNDS?

Long duration funds, as the name suggests refers to bond funds that invest in a mix of debt assets that have McCaulay Duration (MD) of 7 years and above. First a word on McCaulay Duration. This is different from the maturity and the McCaulay Duration of any interest bearing bond is less than the maturity of the bond. That is because, the duration of the bond calculates the number of years it takes for the present value of cash flows from the bond to be equal to the current bond price that you pay.

For instance, if you have a liability maturing in 8 years, then you should match with a duration of 8 years and not maturity of 8 years. Only zero coupon bonds have duration equal to the maturity since there are no intermediate cash flows in this case. What is important to know from an application perspective is that longer duration bonds are more vulnerable to changes in the interest rates, as compared to shorter duration bonds. That is why, all long duration funds carry a high element of interest rate risk.

WHY INTEREST RATES ARE EXPECTED TO FALL

That brings us to the question, why should an investor buy into long duration funds? Clearly, the high interest rate risk means that a fall in the interest rates will magnify in the form of capital gains on the bonds, which will expand the NAV of these long duration funds. Here is why the fund expects the interest rates in the Indian economy to eventually come down.

1. The one factor that has a profound impact on the interest rates is the current account deficit. Normally, wider the current account deficit (CAD) rates tend to be higher. However, it also means that as CAD come down, the rates should also ease. In India, while the merchandise trade deficit has been volatile, the services surplus has been growing rapidly and that is pushing down CAD. In September 2022, the CAD was at nearly 4% of GDP, but is now down to just 1% of GDP and is expected to fall further. That is likely to drive rates lower.
2. Shrinking fiscal deficit (budget deficit) is another factor in easing of rates. In the interim budget, the government has cut fiscal deficit estimates from 5.9% to 5.8% for FY24 and cut the fiscal deficit sharply to 5.1% for FY25 and, possibly, below 4.5% for FY26. Lower fiscal deficit means lower borrowings and less pressure on the interest rates. That normally tends to bring down the rates and also the bond yields in the economy.
3. With Indian government bonds finally being included in the JP Morgan Global Bond index, it is estimated that passive debt funds (index funds and index ETFs) would infuse around $25 to $30 Billion into Indian debt. That has led to early buying by FPIs in Indian debt. This demand has raised the bond prices and brought down the bond yields. This trend is expected to continue.
4. Another key factor that influences interest rates is the level of inflation. India’s headline inflation is down to 5.1% in January 2024 and core inflation is down to 3.6%. Lower inflation is normally the most obvious trigger for falling interest rates. While the RBI may wait for the full budget before cutting rates, the bond yield impact is likely to be visible sooner, if inflation continues to taper in this fiscal year.
5. Finally, interest rates must always be seen in a global context. Apart from the US, the UK, EU, and India had consistently pursued hawkish policies through most of 2022 and part of 2023. Now, UK is officially into recession, and EU is struggling. While the timing of rate cuts is not clear, it appears that the global rate hike cycle may have peaked. That is good news as it sets the tone for rates to fall in the future.

The gist of the argument is that there is a strong case for interest rates in India to fall and bond yields to taper lower. That would present the perfect basket case for investing in long duration funds to make the best of falling rates.

HOW INVESTORS CAN BENEFIT FROM LONG DURATION FUNDS?

Long duration funds, as the name suggests are the funds that invest in bonds with maturity of 7 years and more. Here are how the long duration funds can benefit investors.

• The long duration funds assume peak rates, which is substantially, if not entirely correct. That means, an investor investing in a long duration fund at this juncture is able to lock their investments in conservative investments at peak rates that are assured for a long time. That is something most conservative investors have been waiting for.
• The biggest gain on such long duration funds comes from capital gains when the bond yields start to fall. When it comes to bonds, the price of the bond is inversely related to the bond yields. As interest rates fall and bond yields start to fall, the price of these bonds rise, resulting in capital appreciation.
• Of course, one must bear in mind that if rates go up, it can also result in MTM capital loss. However, this is a game of probability. Just to get an understanding; if you buy a 7.2% government long duration bond and if rates are cut by 50 basis points (-0.50%), then the MTM gain is around 5.5%. That means, you earn 12.7% in a year and over a 3 year period, the CAGR yield goes up by 96 bps to 8.16%.
• Finally, there is the tax angle. Remember, debt funds do not offer benefits of capital indexation FY24. However, in a mutual fund, it is possible to structure the payout as SWP (systematic withdrawal plan) and still make it tax efficient.

The long duration fund can combine the benefits of high coupon, capital gains and tax efficiency into one well-rounded package.

BANDHAN LONG DURATION FUND – WHO SHOULD INVEST?

Here is what investors need to understand about the logic of investing in the Bandhan Long Duration Fund from an investment fit perspective.

• The Bandhan Long Duration Fund is suited to investors who are seeking higher returns, but also with a higher tolerance for volatility risk. Remember, this fund is low on credit risk, but high on interest rate risk.
• This fund is also suited to investors seeking regular income with a long term holding capacity. However, it is suggested that investors structure their withdrawal of funds via SIPs, so that it is also tax efficient.
• This fund is best suited to investors who want to minimise their reinvestment risk in a scenario when rates are more likely to fall.

The Bandhan Long Duration Fund is suited to a very niche audience among the conservative investors. It is best to check the fit before investing.

PERFORMANCE OF LONG DURATION FUNDS IN INDIA

Here is a quick look at the leading long duration funds in India as of March 01, 2024. These are CAGR returns for beyond 1 year, and pertain to direct plans, growth option.

Scheme  Name	NAV  Direct	Return (%)  1-Year	Index (%)  1-Year	Return (%)  Launch	Index  (%)  Launch	Daily  AUM #
Aditya Birla Sun Life Long Duration Fund	11.57	10.74	10.32	9.79	9.43	101.85
Axis Long Duration Fund	1,119.95	10.16	10.32	10.09	9.19	200.85
HDFC Long Duration Debt Fund	11.14	10.90	10.32	10.16	9.36	2,068.64
ICICI Prudential Long Term Bond Fund	87.24	9.70	10.32	8.13	N.A.	733.72
Nippon India Nivesh Lakshya Fund	16.32	10.11	9.34	9.05	8.53	7,258.44
SBI Long Duration Fund	11.27	11.14	9.34	10.51	8.31	1,448.44

Data Source: AMFI India (# – ₹ in Crore)

To get a picture of how these long duration funds have performed, we have considered 1-year returns, returns since launch; and juxtaposed them with the respective indices. For all these funds, only direct plans are considered since that gives a cleaner picture of fund performance without letting the total expense ratio (TER) distort the picture. There are 6 open ended long duration funds in India managing a total corpus of nearly ₹11,812 Crore. Out of these 6 funds, just 1 fund; Nippon India Nivesh Lakshya Fund manages about 62% of the entire corpus of long duration funds in India. Here are the highlights of the performance of multi-asset allocation funds across time frames.

• On a 1-year returns basis, the long duration funds universe in India has generated maximum returns of 11.14%% and minimum returns of 9.70%, showing very limited variation due to similarly portfolio of most funds. The average returns over a 1 year period are 10.46%, but 1 year may actually be a very short time frame.
• Based on returns since launch, long duration funds universe in India generated maximum returns of 10.51% and minimum returns of 8.13%, again showing very limited variation due to similar portfolio of these funds. The average returns since launch were 9.62%, but here the returns have less to do with the period and more with interest rates.
• We have also tried to compare the performance of these funds with their underlying benchmark across maturities. On a one-year returns basis, the maximum returns, minimum returns, and the average returns of the family of long duration funds has done better than the underlying indices to which they are benchmarked. A similar trend is visible on returns since launch basis also; although individual funds have been more volatile on the downside.

One quick takeaway is that, investors can only expect some positive surprises on these funds, if the interest rates trend lower, and even that impact will be more pronounced in the short term.

GLANCE AT THE BANDHAN LONG DURATION FUND NFO

Here are some details of the Bandhan Long Duration Fund NFO you must know to decide on investing in the fund.

1. The NFO of Bandhan Long Duration Fund opens for subscription on March 05, 2024 and will close on March 18, 2024. The scheme will open within two weeks for continuous sale and purchase at NAV-linked prices.
2. The Bandhan Long Duration Fund NFO offers an opportunity to investors to participate in a diversified portfolio of bond assets (government bonds and corporate bonds) which have McCaulay Duration of more than 7 years. Here, it must be noted that long duration funds tend to be more vulnerable to changes in interest rates.
3. Entry loads do not exist in India. Exit loads will not be applicable on this fund. However, this is a long duration debt fund and hence investors must decide the holding period based on the impact of long term capital tax and also the need to hold a bond portfolio through cycles to make the best of the returns.
4. In the NFO, investors can put in applications for a minimum of ₹1,000 and in multiple of ₹1 thereafter. Additional purchases on an ongoing basis will also be at a base of ₹1,000, and in multiples of ₹1 thereafter.
5. The fund offers Regular and Direct plans for the investors. In addition, investors can either choose the Growth option or the IDCW (income distribution cum capital withdrawal) option. Dividend plans offer payout and reinvestment options.
6. The Bandhan Long Duration Fund will be benchmarked to Nifty Long Duration Debt Index A-III index. Now, A-III refers to a combination of the plots of credit risk and interest rate risk. A-III refers to a bond instrument with low credit risk and high interest rate risk.
7. In terms of the fund management, Gautam Kaul will manage the debt portion, while Sreejith Balasubramanian will manage the overseas debt portion. The core focus of the fund is to enable investors to capitalize on the expected fall in interest rates.
8. The Bandhan Long Duration Fund will be a bond fund, with debt over 7-years duration being the predominant investment. Effective Budget 2023-24, the benefit of indexation on long term capital gains on debt funds (less than 35% equity) has been withdrawn. Hence for taxation, these bonds funds will be at par with fixed deposits.

The Bandhan Long Duration Fund NFO is an opportunity for investors to play the expected tapering of interest rates in the Indian economy through a portfolio of long duration bonds. These funds can generate above average returns in a falling interest rate scenario.