Best Debt Funds

1. Ultra-Short Duration Funds

ULTRA-SHORT DURATION funds, which include categories such as ultra-short duration, low duration and money market funds, are ideal for risk-averse, short-term investors. The top-performing fund in the category — Nippon India Money Market Gr — had rolling returns of 4.89% (as on September 30, 2023). Maintaining a conservative duration of 120-180 days (money market funds can invest in assets with maximum maturity of up to one year), and a healthy balance between asset quality and carry (direct cost paid by an investor to maintain a security position) played out well for the fund this year.

“The discipline of maintaining duration in a range has also helped the fund perform in a volatile interest rate scenario,” says Anju Chhajer, senior fund manager, fixed income, Nippon India Mutual Fund. In terms of asset quality, 60-70% of the fund’s portfolio was invested in issuers rated long-term AAA and AA+, while 15-25% was in sovereign instruments. “This is an all-weather fund, which works in all the market scenarios — especially for investment time horizons of two-six months,” adds Chhajer.

UTI Money Market Reg, the second-best performing fund in the category, returned 4.85% last year. Finding value across the yield curve, and active duration management have been central to the fund’s strategy, says Amit Sharma, vice president and fund manager, debt, UTI Mutual Fund. “We had a strong conviction that central banks, including RBI, will keep rates high till they see inflation aligning to their target. We remained moderately lower on duration due to our view that short-term rates may remain under pressure in an environment of strong credit growth and consequently heavy duration supply amidst a backdrop of tighter liquidity,” he says.

A robust investment framework and managing the interplay of credit, liquidity, and interest rate risks have been instrumental for Aditya BSL Money Mgr Reg, which secured the third spot, with returns of 4.82%. “The market does give investing opportunities which can be identified with a robust investment and risk framework,” says Kaustubh Gupta, co-head, fixed income, Aditya Birla Sun Life AMC.

2. Short-Duration Funds

SHORT-DURATION funds invest in debt and money market instruments with portfolio duration between one and three years. The category of funds are an attractive bet for short-term investors.

According to Chandni Gupta, fund manager, fixed income, ICICI Prudential AMC, the top-performing funds in the category — ICICI Pru Banking & PSU Debt Gr — benefited from strong economic fundamentals, while robustly capitalised banks and a strong corporate sector were good background for accrual strategies. “During 2018, mutual funds were just coming off a bad credit cycle, when the markets were hit by banking non-performing assets (NPAs). Given this experience, over the past three-four years, investors have been averse to credit and spread space. This year, the economic background was supportive, and our investment philosophy of focusing on yield to maturity (YTM)-accrual based strategies worked well for us. We found good investment opportunities in top-quality AAA names with good spreads, a call which worked well for the fund,” says Gupta.

For the second-best performing fund in the category — ICICI Pru Short Term, a strategy of not being index-focused helped. “At a different point in time we could use various strategies such as floating rate, fixed rate or a barbell strategy in the fund rather than just focusing on the index,” says Manish Banthia, CIO, fixed income, ICICI Prudential AMC.

Going forward, ICICI Pru Banking & PSU Debt Gr will continue with the accrual strategy, says Gupta. “When it comes to growth, we believe India is in a mid-cycle and the growth story has legs, with credit growth yet to plateau… Post-election, we believe private capex will take off… Given this setting, we believe accrual strategy could deliver better investment experience.”

3. Long-Duration Funds

THE TOP PERFORMER in the long-duration funds category — ICICI Pru All Seasons Bond — delivered 5.10% rolling returns last year (as on September 30, 2023). According to Manish Banthia, CIO, fixed income, ICICI Prudential AMC, what makes the fund attractive is the large amount of flexibility — in terms of duration, moving between fixed and floating rate assets, G-secs, and AAA and AA bonds. Flexibility, however, comes with risks, and hence, there are frameworks that guide the fund’s strategy, says Banthia. “This year, too, we used the same framework which guides us as to how the economy is shaping up and accordingly what kind of duration should be run,” he adds. “We also take exposures in assets like state development loans or corporate bonds, AA and AA bonds depending on how the spreads are moving. The spreads were tight for the entire 2023 and our exposure to government securities was very high. I expect that the spreads should normalise next year and if that happens, we will be able to add additional accrual assets to the fund.”

For ICICI Pru Gilt Gr, the No. 2 in the category, with rolling returns of 4.83% in 2023 (as on September 30), the strategy to stay underweight in terms of duration compared to peers and the benchmark, paid off. “We thought that duration was not the right investment for our clients right now. We stayed invested in high-quality YTM securities and floating rate bonds. At one point in time, when valuations were very attractive, 60% of our fund was invested in floating rate securities,” says Anuj Tagra, fund manager, fixed income, ICICI Prudential AMC.

SBI Magnum Gilt Reg Gr grabbed the third position in the category, with rolling returns of 4.66%. According to fund manager Dinesh Ahuja, the fund follows a top-down approach by taking a medium-term view on interest rates while being alert to tactical opportunities based on near-term demand-supply dynamics. “The portfolio has been alerted to capitalise on market volatility,” he says.

Going ahead, there are some concerns over these funds owing to expectations of economic uncertainty. According to Dinesh Rohira, founder and CEO of investment advisory 5nance.com, long-duration funds bring in a substantial probability of volatility by design. “If you look at a five year horizon or more, you’re bound to look at some economic downturn in that cycle. And that’s going to impact the performance of this play... We have been in a good economic cycle and we expect to be there for the next one year, but beyond one year, we don’t have great visibility,” he says.

4. Corporate Bond Funds

CORPORATE BOND funds, which require a minimum 80% investment in AA+ and above-rated bonds, posted average returns of 5.93% YTD (as on December 18, 2023). These are suitable for investors who want to invest money for longer duration but prefer less-risky assets compared to equity funds.

The top-performing fund in the category — ICICI Pru Corporate Bond Gr — had rolling returns of 5%, benefitting from investments in floating rate bonds. While the fund continued to invest in AAA PSU and AAA banking names, as well as government securities (G-secs) during the year, investments in floating rate bonds helped it stand out, says Anuj Tagra, fund manager, fixed income, ICICI Prudential AMC. “This approach worked well for us, because in this rate cycle, where RBI moved from 4% to 6.5%, these bonds delivered good returns to investors and emerged as a major differentiator for us,” says Tagra. Going ahead, the fund will continue to invest in top AAA names, and will pick and choose some good private names, which seldom come to the bond markets, but they deliver decent YTM to clients, he adds.

Aditya BSL Corporate Bond Reg Gr was the second-best performer in the category with 4.76% rolling returns in 2023. “The core investment strategy this year was incorporating probability distribution in investment decisions,” says Kaustubh Gupta, co-head, fixed income, Aditya Birla Sun Life AMC. “This is important today, when too much information is available in financial markets and because of the elevated uncertain times markets are exposed to. Fund portfolios are split into a core part which looks at strategic investments and follows an accrual strategy. The satellite portion is managed more tactically, and thus, churned regularly based on evolving opportunities,” he adds.

Meanwhile, for Kotak Corporate Reg Gr, No. 3 in the category, a portfolio mix (allocation to fixed and floating rate bonds) and active duration management have been key to the fund’s investing strategy last year. “The fund largely follows a buy and hold strategy and duration of the fund is managed through 10-15% of the fund. The strategy also included active duration management and identifying the cheap segment across the yield curve,” says Deepak Agrawal, chief investment officer, debt, Kotak MF.