Think Debt : Advisor Perspectives 22nd May 2015
Words of wisdom from a duration call champion
Sunil Jhaveri, MSJ Capital, Gurgaon

imgbd A true champion is one who willingly shares his winning ways, but only after cautioning you and ensuring that you first know what you are getting into. Mr.Bond's article earlier this month (Click Here) alerted you to the fact that duration strategies are not for all - certainly not for retail investors who do not have stomach for bond market volatility, and for advisors who cannot take independent entry and exit calls in duration funds. In the second part of this series, he shares with us a succinctly written beginners guide for advisors who wish to understand how to take duration calls for clients who do have the appetite for such products. Starting from the basics of what drives bond markets, Mr.Bond then shares facts and figures that will help you understand when you should take duration calls and when you shouldn't.

Think Debt, a joint initiative between ICICI Prudential MF and Wealth Forum, endeavours to showcase new paradigms in debt funds, and smarter ways to position debt funds to grow this category many times larger than what it is today.


Many readers have interpreted my earlier article on why duration themes are not for retail investors (Click Here) as understanding that I am totally against Duration calls. If one has read the article thoroughly, one would have realized that I had also given investment calls from time to time to my Institutional investors including in 2008 November; but followed it up with aggressive disinvestment calls as well. I am not & have never been against giving Duration calls. I have only been stating at various forums & platforms that these calls are not for Retail investors who have come into Mutual Fund Debt schemes for predictability, lower volatility & better tax efficiency. Neither have I spoken in favor or against Duration call in that article. Entire gist of the article was that Duration themes are more like trading calls, need constant monitoring, need timely entry & exit calls & should be given by those advisors who understand when to give disinvestment calls & to those investors who are savvy on these issues.

My only observations & conclusion after showing some hard hitting facts & figures was (to recapitulate):

"Please note that I am not suggesting through this note about the possibility of Income Story panning out or not. That only time will tell. All I am suggesting through this note is that:

  1. Advisors should give investment call in an asset class (especially duration in debt schemes & sector calls in equity schemes) only when you are capable of giving disinvestment calls at right times

  2. Retail investor portfolios can surely do without this asset class & reduce volatility in their portfolios. Their investment mandate starts from the premise that they were happy with 6% post tax returns without any volatility

  3. Both AMCs & Advisors need to understand as to which segment of investors these duration calls are targeted. If sold to retail segment (which as I have been saying should never be done), explain the RISKOMETER before coming out with these calls"

Another aspect which I had forgotten to highlight (& which has a great bearing on these calls) is that since these calls become trading calls, investments in Duration themes may not be held for more than 3 years. In such an instance, investor ends up paying short term gains tax; thereby further diluting returns to the investors.

Hence, readers need to understand what I am about to write & then figure out if these ideas are suitable for their investors based on their need, profile, cash flow requirements, etc. Going forward, all debt solutions (except for short term cash & emergency cash requirement needs) will have to be pitched as 3 year plus alternatives to 3-5-10 year Fixed Deposits. Our biggest competition as mentioned in my earlier note was and is 3 year plus FDs. Hence, to have the additional advantage of long term gains tax, lower volatility (there is more volatility over shorter term than in longer term both in debt & equity markets) & better credit, we need to pitch 3 year plus debt solutions to investors.

What are the main factors which determine debt market directions? :

Besides many extraneous factors both technical & fundamental like monsoon, international crude prices, geo political issues, global commodity trends, global liquidity, gold prices & import figures etc. (which also has impact on main factors affecting domestic debt markets as well) - following are the main factors determining debt market directions:

  1. Total Credit in the System - External & Internal

  2. External - Gets determined by Current Account Deficit/Surplus

  3. Internal Credit is further divided into - Private Sector & Government Sector

  4. Private Sector Credit - gets determined by Credit Growth & Government Credit by Fiscal Deficit

Following chart shows these inter relationships


  1. When CAD, Credit Growth & Fiscal Deficit; all three are on the higher side, there is huge supply of paper (from private sector as well as Govt sector); thereby pushing the yields up. This was witnessed in FY 2013 when both CAD & Fiscal Deficit numbers hit through the roof with modest credit growth. Yields went beyond 9% on 10 year benchmark

  2. Currently Fiscal Deficit number has come down from a high of 4.70% to 4% & hopefully to 3% in next couple of years. CAD has come off from a high of almost 6.50% (third quarter of 2013-14) to less than 1.50% currently with a possibility of surplus position in quarter ending March 2015 (figure yet to be announced) & Credit Growth at very low levels of 9.50%, points towards a situation of softening of interest rates in the near future

  3. Of course, as mentioned earlier, other extraneous factors will give volatility to this debt market journey with an upward bias over shorter duration (read 6-12 months) but a downward bias over medium to long term (read 12-36 months)

  4. Above correlation is captured by a leading fund house's Long Term Plan which follows a Quant Model based on above Debt Market Constituents

  5. It captures above data points & has created a Quant Model based on Current Account (known as CA Index).

  6. This quant model increases average maturity & modified duration when CA Index moves into positive territory & vice versa

  7. This takes away human bias in terms of increasing/decreasing average maturities & does not try to outguess markets

  8. Also, this scheme takes care of dilemma of getting out of Duration themes over shorter periods of time; thereby making these calls tax inefficient

  9. Instead of the investor exiting the scheme/theme, the said scheme will increase/decrease maturity between 1 to 10 years; thereby doing away with requirement of active disinvestment calls (which unfortunately is never forthcoming)

As mentioned earlier, our investments in debt schemes should be for 3 year plus to make it more tax efficient. I have done some number crunching based on three data points (for investments made between January 1'2004 & May 15'2015):

  1. Investments in Duration themes when 10 year breaches 7.75% (currently quoting at 7.91%)

  2. Investments in Duration themes when 10 year breaches 8% &

  3. Investments in Duration theme since Jan 2004 without timing the entry points as mentioned above & subsequent 3 year rolling returns

  4. I have selected top 5 Income schemes for this purpose viz. HDFC Income Fund, ICICI Prudential Income Fund, Kotak Bond Scheme Plan A, Reliance Income Fund & Birla Income Plus Fund

  5. These observations do not include data for investments which have not completed 3 year investment cycle viz. it will not have data of investment made in say June to September 2013 (when 10 year benchmark had breached 9% levels) as the same have not completed 3 year period

Investments in Duration themes when 10 year breaches 7.75%:


# Lowest return of 5.80 % was achieved on August 19'2013 (when 10 year benchmark touched 9.24% for investment made on August 19'2010 when 10 year benchmark was 7.89%)


Following are the observations for the Tables (A & B) depicted above:

  1. Since 2004, if an investor would have invested in any of the above named Income schemes when 10 year benchmark had breached 7.75%, Minimum returns generated over 3 year period (point to point) was 5.80%; Maximum of 12.66% with an Average Return of 9.58%

  2. Almost 80% of the observations had generated more than 8% returns & 65% of the observations had generated more than 9% returns

  3. With Indexation, hopefully this average pre tax returns of 9.58% would be post tax as well

  4. Even Standard Deviation is on the lower side at 1.53

Investments in Duration themes when 10 year breaches 8%:


Following are the observations for the Tables (C & D) depicted above:

  1. Since 2004, if an investor would have invested in any of the above named Income schemes when 10 year benchmark had breached 8% & above, Minimum returns generated over 3 year period (point to point) was 6.95 %; Maximum of 12.66% with an Average Return of 9.67%

  2. Almost 82% of the observations had generated more than 8% returns & 65% of the observations had generated more than 9% returns

  3. With Indexation, hopefully this average pre tax returns of 9.67 % would be post tax as well

  4. Even Standard Deviation is on the lower side at 1.53

Investments in Duration themes without Timing the Entry Levels:


Following are the observations for the Tables (E & F) depicted above:

  1. Without timing your investments (unlike in the tables A,B,C & D above which showed results for investments done when 10 year benchmark breached 7.75% & 8%), 3 year rolling returns of the same 5 Income schemes showed Minimum Returns of 2.10%, Maximum Returns of 12.53% & an Average Returns of 7.77% over 3 year holdings with only 46.22% of observations generating returns above 8% p.a.

  2. Hence, it is advisable for investors to time their investment & not blindly invest in Duration themes at any levels of interest rate cycle

  3. Here Standard Deviation has jumped to 2.03 indicating increased volatility in investment returns if an investor had not timed the entry levels


  1. Investing in Duration themes can & has generated decent returns over 3 year plus investment horizon; if entries are timed well

  2. After timing the entry points, it is imperative to hold these investments for 3 year plus for better tax efficiency

  3. Those who are not capable of timing entry as well exits out of these themes; it is better to invest through quant model schemes like ICICI Prudential Long Term Plan

  4. All macro parameters are pointing towards softer interest rate stance; with intermittent volatility with upward bias over short term

  5. One can invest in a staggered manner from now to say 3 months hence; thereby taking care of investing at different entry points

  6. Differentiate this call from my earlier article which was meant to dissuade those advisors who are managing retail business & can do away with volatility from their portfolios & those who are not capable of timing entries & exits

  7. This call will reduce credit risk which is creeping into high accrual themes

  8. Investors have always looked at Predictability as one of the main criteria for selecting a debt scheme. That is the reason why accrual themes following draw down/roll down strategies work like a formula viz. Net YTM +/- 100/200 bps; thereby giving predictability of returns

  9. Similar situation can be seen from the data above on Duration themes; wherein investments made at 8% plus levels have over 3 year period generated between 7- 12.66 % p.a. i.e. YTM of 8% less Expense Ratio +/- 100/200 bps depending on interest rate going up or down during that period

  10. Last but not the least, understand what levels of market understanding that is required in terms of entry/exit levels, understanding of various debt market constituents to take an informed decision for Advisors to invest their client funds into Duration themes

  11. Hence, do not blindly invest in any asset class without putting things in right perspective, after some extensive number crunching, explaining all risks in investing in these themes to the investors & guiding them through up & down journey through their investment cycle. If not, do not approach that asset class

  12. This asset class due to its inherent nature will have huge volatility attached to it. If explained in advance to the investors & guide them through rough patches & goading them to hold for recommended investment horizon (in this case minimum 3 years) & timing the entry levels as mentioned above, investors will be a happy lot both on pretax & post tax basis without taking any credit calls

  13. If one panics during volatile periods & redeems (as was the case in August 2013 period), one would lose the advantage & come out at sub optimal returns without ever coming back to this asset class


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