Mutual Fund

Franklin India Ultra Short Bond Fund: Is it time to exit?

“You either die hero or live long enough to see yourself become the villain.”  –  from The Dark Knight

Franklin India Ultra Short Bond fund was launched in Dec 2007 and has a history of 12+ years with return since launch of 8.57%. In the current mayhem in the markets and the series of credit risks events, people have been losing their confidence on the debt funds. I have been personally invested heavily in the bond funds, and FI-USB has been one of the few funds in my portfolio with significant exposure. In the last 7 years of investing in the fund and keeping 8.9%+ return is a pleasing experience, this is partially due to timely reducing exposure by half, before the Vodafone-Idea side pocketing (hit of ~4.4%). Lot of people are invested in this fund and in the recent month, it have given -ve return on 9 out of 20 days. It has obviously caused the concern in investors and they worry about any other credit event. Let’s try to analyse this fund with its historical/ current data to take our call instead of relying solely on emotional response. (Why not emotional response?)

Historical Return Profile

In the last 12+ years history, the fund has given 8.57% of CAGR. I looked at the 3 yr rolling return for various periods as below. The worst return scenario has been 6.94% annual return for 3 yrs (Mar 2017 to Mar 2020) and best has been 10.1% return (Nov 2011 to Nov 2014). The mean as well as median return for this fund has been 8.9%, which is nothing but phenomenal.

FIUSB 3yr RR

Yield to Maturity (YTM)

I have explained in earlier write-ups, why YTM is more important then the historical returns profile (Historical vs Future Returns). The yield to maturity reflects the expected return generated from the current bond investments by the fund over the duration of investments in case of no credit risk event (defaults). The current YTM of the fund is 9.48% for a duration of 0.62 years, this is pretty attractive return from the bond fund.

If you have been a regular reader of my articles, by now you would have realized that I am more concerned about the risk i am taking in my portfolio vs the return I am generating. So let us analyse the risk profile of the fund to make the complete assessment.

Credit risk

This fund has always been more risky then it’s counter-part just by the virtue of taking more credit risk. To understand this in more details, Let’s understand the riskiness of bonds in terms of ratings. As a short term debt fund, our benchmark is Govt Treasury bills which are theoretically risk free. In increasing level of risk below should be the sequence: Sov -> AAA/ A1 -> AA/ A2 -> A/ A3 -> BBB/ A4 -> C or D.

The fund has no exposure/ investments in the Sov and <2% exposure in AAA/ A1 instruments. Majority of the investments are in AA rated bonds ~84% and 22% in A & below rated bonds. Therefore from the fund definitely has a higher credit risk. Most of the bonds are from the NBFCs, which seems more vulnerable in current scenario of lock-down in my non-expert opinion.

Another way to mitigate this risk is to diversify and have lower exposure to a single company or bond. It currently holds 88 different bonds but Top 10 holdings make ~40% and biggest exposure being >7%. if any of these defaults, it will be a big dent again.

Liquidity Risk

What is Liquidity risk? Liquidity is a measure to understand the ability to translate the investments into cash by selling, for e.g. If you have a residential apartment worth 70lakhs, and you have to sell it to generate cash within 10-15 days there is a very high chance you will end up realizing <70lakhs even if you are able to sell it. That is because of lower liquidity of the real-estate market.

Why it is important? The fund has seen the pressure of accelerated redemption over the last 6 months. it has lost half of its AUM from 20,130 Cr in Sep 2019 to 10,964 Cr in Mar 2020. Losing roughly 1,500 Cr every month.

This has taken the toll on the fund as it has to liquidate its more liquid and safe investments in AAA/A1 category. In Sep 2019, it had 27%+ investment in AAA/A1 to <2% in Mar 2020. It means if the fund continue to face the similar level of redemption, it will have to liquidate the AA category bonds, which will be loss making trades in general. The fund is already having -7% cash/ call money investment, which means it had to take a loan/ overdraft to meet the redemption pressure. It is also important to note that fund has ~30% investment in the bonds maturing in 2022 or afterwards. 

Re-Investment Risk 

If my investment horizon is 3 years and the fund duration is 0.62 years, It means that the funds investment will mature and need to be re-invested. As we seen the RBI has lowered the interest rates, the new investments bonds will also be yielding lower returns if the credit risk is same. This means that the YTM of 9.48% is not sustainable and will move lower.

Interest Rate Risk

This i have covered earlier but in summary if the duration of the fund is higher then the increase in interest rate will be negative for fund profile and vice-versa. Since the Modified duration/ duration is <1yrs, the fund has a lower interest rate sensitivity though higher vs peers in same category.

In Summary, The fund has an attractive return profile but the risk levels are definitely higher.

  1. If you have a higher risk appetite and the investment in this fund is not your emergency corpus or for short term goals, you can stay invested in the same. Please be vigilant on the redemption pressure, if that continues for few more months, it will be unsustainable.
  2. If you have invested for short duration, and your goals are due in next 3 yrs or this is your emergency corpus, it will be more prudent to sell and get out of this fund.
  3. If you have not invested but are thinking to invest in this fund, please re-evaluate your decision. You can read about how to build your debt fund portfolio for more details.

In my humble opinion in current scenario, for additional 1% to 2% returns the risk exposure is not justified. One should size their exposure in this fund accordingly. It’s always better to be safe than sorry, Let me know your assessment.

Happy Investing!

 

Investment Objectives & Advice

Do’s & Don’ts during the Market Panic!

The markets are crashing, it has fallen from the cliff and wiped out the gains of last 3-4 years. There is flurry of queries about; What should i be doing? Is this an opportunity to buy more? Is this the end of markets, should i pull out all my money out of equity markets? These are unprecedented times and any suggestions on the current time will be an educated guess only. There are some evergreen basics and when i see lot of people breaking those & it pains. This article is to address such basics:

Should I sell in current panic? Lot of investors did ask this question, What if i sell now and buy again later. In the process, they want to avoid the chances of further losses. This is a common thought and happens with many investors, The problem with this approach is that you have never timed the market and now you want to. You are underestimating the emotional part of decision making: How would you know the exact bottom of the market? if the market stops falling and start increasing again is your indication then think again. It did happen twice when the market rallied quite a bit from it’s bottom to fall again. Most often people, who sell to buy again later at cheap levels end up missing the recovery to a large extent. Therefore, Do not sell in Panic, there can be other reasons to sell which i flagged earlier. (Should i sell now?)

  1. Sell if you want to harvest the losses to avoid capital gains tax
  2. Sell if you had to replace a laggard fund in your portfolio with another
  3. Sell if you do not have sufficient emergency corpus ( If this is the case, Please fix your basics)
  4. Sell if your goals are in next 2-3 years itself ( Not sure why you would be in equity still!!)

In equity every few 3-5 years, there is a chance of correction and if the correction is large then the recovery years can also be successive or large positives. It is not like fixed deposits (giving you consistent returns every quarter). Below is the annual return for Last 20 years in Nifty 50 TRI and the 5 yr geometric mean returns. In all years, there has been different return and even on a 5-yr horizon it could be anywhere between 0.5% (2008-2012) to 43.7% (2003-2007).

Annual Returns of Nifty 50 TRI

Should I buy with borrowed funds (leverage)? This might be a surprise to few but there are some brave souls, who want to buy in this market. They do not only want to buy with extra cash they have, but also ready to take loans. They also want to break there FD’s to buy in this market. A simple suggestions to such people in my humble opinion is that, It is never a good idea and should not be done as a retail investor. Please stick to the basics: Stay with in your asset allocation, re-balance your portfolio bi-annually or annually.

Should I stop my future SIP’s or regular investments? The answer to this question is circumstantial. I spoke to few people, who might see a challenge in their job security or might face a cash flow problem. For such people, It is ok to stop their new investments. Though if you want to stop investments as the market is falling, then please do not do it. In the volatile market, regular monthly investments help you limit the absolute downside and help you accumulate more units (Time Diversification)

Is it time to buy, should I increase my investments? Again the answer to this question is circumstantial. If you are under invested in Equity, yes you should buy more now. If you have been sitting on cash due to concerns related to market overvaluations, yes you should buy more. If your earnings capacity is intact and your saving proportion increasing, yes you should buy more. All in all, If you know the right reason why you want to buy more/ you are Ok to stay invested for long time horizons/ You are Ok to see another 15-20% fall in investments or if you are Ok to not get any returns in the next 2-3 years, yes you can buy more. If nothing else, the current market levels have brought the trailing valuation ratios to an attractive zone.

VI Index as of Mar 20, 2020

*As of Mar 20, 2020

Just to summarize, There is no universal answer. In a market at any point in time, there is a buyer & for every seller (& vice versa) for trade to happen. You should not act based on emotional reactions in the market currently but because of your plan with solid reasoning  without sacrificing the financial security.

 Happy Investing!!