Best Performing 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 the risk-averse who want to invest for the short term. Ultra short term funds have delivered 4.07% return this year, against 3.85% by low duration funds and 4.03% by money market funds. In a year marked by multiple rate hikes by the RBI, fund managers had to carefully walk the path.

For this year's top-performing fund in the category in the Fortune India-Morningstar study —ICICI Prudential Savings Fund— the strategy was to maintain a low duration and exposure to floating rate bonds. "The portfolio was reasonably underweight against the benchmark as we were cautious that the RBI will be moving away from extremely easy monetary conditions. Besides, staying away from the overvalued points on the curve such as the 1-5 year maturity, too, aided portfolio performance," says Rahul Goswami, CIO, fixed income, ICICI Prudential AMC.

Kaustubh Gupta, co-head, fixed income, Aditya Birla Sun Life AMC, which runs the Aditya BSL Savings Fund, the second on the list, says a modulation of duration play has helped the fund outperform other cash-like assets on a consistent basis. "We chose to run, at least for the first six months, a somewhat higher duration. When the RBI increased the pace with rate hikes, we brought the duration lower. We were not only able to get better carry (a kind of performance fee), but also limit potential mark-to-market losses."

The third on the list, Nippon India Money Market Fund, did not invest in issuers rated below AA (long term), but focused on high-grade short-term sovereign and money market instruments to ensure high liquidity and asset quality. What worked for the fund this year was capping the average maturity/duration at 160 days to ensure limited volatility, says Anju Chhajer, senior fund manager, fixed income, Nippon India MF.

2.Short to Medium Duration Funds

SHORT TO MEDIUM TERM FUNDS registered a subdued performance this year, delivering a category average return of 3.87%. The three best performers in the category, according to Fortune India study — ICICI Pru Medium Term Bond, Axis Strategic Bond, and SBI Magnum Medium Duration — were, however, able to perform better than peers, thanks to smart moves by fund managers which helped investors get through a difficult year. "To protect investors against an environment of rising interest rates in 2022, we reduced duration below the specified three-year range and continued to focus on AA-rated assets to enhance portfolio yield-to-maturity (YTM)," says Manish Banthia, deputy CIO, fixed income, ICICI Prudential AMC.

Though the segment took a major hit post April, the fund (SBI Magnum Medium Duration Fund) was able to do well, says Dinesh Ahuja, fund manager, fixed income, SBI Mutual Fund. "We were sitting on a significant amount of cash when bond yields spiked. We have been able to gradually build our portfolios at higher yields and take tactical calls on the government bond side, which has led to superior returns compared to peers," says Ahuja. The fund has been ranked third.

For Axis Strategic Bond Fund, which grabbed the second spot, it was the barbell strategy that worked — where an investor buys short- and long-term bonds and avoids medium-term bonds, like a physical barbell. It works best in times of volatile interest rates. When rates rise, short-duration bonds are traded for higher interest issues. When rates fall, long-term bonds come to the rescue since they have locked in those higher interest rates. "Buy the extreme short end of the curve and hold the long end, because the belly of the curve saw the maximum hit since the rate hikes were front-loaded and the pace was faster thanks to the Russia-Ukraine crisis. We invested a lot of our assets in the very short term and some in the long end of the curve," says Devang Shah, co-head, fixed income, Axis Mutual Fund.

3.Medium to Long Duration Funds

RETURNS HAVE BEEN MUTED for medium to long duration funds as well. These funds, which invest in debt and money market instruments that have an average maturity of four-seven years, registered a category average return of 2.34% in 2022. Long duration funds, which invest in fixed income instruments of longer tenures, returned an even lower 1.07%.

For the top-performing fund in the category — ICICI Pru All Seasons Bond — the aim was to maintain low duration and maximise portfolio YTMs. "Floating rate bonds played a significant role in this strategy. These were converted to fixed rate bonds using derivative strategies. The absolute yields on floating rate bonds hedged into fixed rate bonds and increased to as high as 8.8–9%, making them extremely attractive," says Manish Banthia of ICICI Prudential AMC.

Rahul Goswami, CIO, fixed income, ICICI Prudential AMC, attributed the performance of the ICICI Pru Gilt fund, the second on the list this year, to its strategy of holding lower duration and long duration papers. "When the rate went up, we were able to benefit at both ends. Apart from that, we also had exposure to floating rate bond funds where we created a synthetic bond structure, which provided a kicker to the portfolio over the last six quarters," says Goswami, adding, the fund invests in government securities across maturities which offer a blend of duration and reasonable yield.

For Dinesh Ahuja of SBI Mutual Fund, the strategy was to invest more in "attractive" government bonds. Its SBI Magnum Income fund was ranked at No.3. "The intention was to have a 40/60 divide — 40% government bonds and 60% non AAA, but since spreads were not very attractive, we had a higher allocation to government bonds," he says. However, with corporate issuers coming back into the system and rates looking attractive, this allocation could change over the next three to six months, adds Ahuja.

4.Corporate Bond Funds

CORPORATE BOND FUNDS are best suited for investors looking for consistent returns without much volatility. Like other categories, this year has been slow for corporate funds as well, with an average return of 2.54%. "This has not been a good year for corporate bond funds because we have been in a rising interest rate scenario. However, if the RBI stops hiking interest rates next year, we might see a better year for corporate bond funds," says Sebi-registered tax and investment expert Jitendra Solanki.

For the top-performing fund in the category — Aditya BSL Corporate Bond fund — active duration play and investing in sovereign papers helped it stay ahead of peers. "This year, our expectation on interest rates was somewhat sober, corporate spreads were absolutely low and there was an overhang of the RBI normalisation cycle. So, we increased allocation to sovereign papers by investing larger proportions in G-Secs and state development loans, instead of corporate bond spreads," says Kaustubh Gupta, co-head, fixed income, Aditya Birla Sun Life AMC.

Meanwhile, Rahul Goswami of ICICI Prudential AMC, which runs the ICICI Pru Corporate Bond fund, second on the list, says a barbell strategy worked for the portfolio here as well. "This strategy was put to use because we were expecting the RBI to move away from extremely easy monetary conditions," he adds.

Devang Shah, co-head, fixed income, Axis Mutual Fund, attributes the outperformance of the Axis Corporate Debt fund, which has been ranked third, also to the barbell strategy. "The fund is run very dynamically, moving around duration. The entire fund is invested in AAA — very pristine quality portfolio assets. The thought process for us is as and when macro looks weak, we increase the duration and vice versa," says Shah.