Duration and Accrual Debt Funds


Debt funds, broadly, follow one of these two strategies.

One type of fund aims to make money out of predicting interest rate movements. Accordingly, it will buy and sell securities to have a particular maturity date of the portfolio. This strategy is called duration strategy.

The second type of fund aims to invest in companies that have a lower credit rating but are well-managed. The intent here is to buy those companies where the fund manager expects credit ratings to improve, which will hopefully lead its price to go up and benefit the fund. This strategy is called accrual strategy.

Many debt funds follow a bit of both strategies, depending on what their market view is. Choosing one over another has a bearing on the returns you could make and risks you take on.

INTEREST RATE RISK: Duration debt funds take a call on the interest rate scenario and position their portfolios accordingly. If they forecast interest rates to fall, they buy longer-dated bonds. If their calls go right, they benefit hugely. But if their calls go wrong, they make big losses. Accrual strategy funds don’t usually take interest rate risk, they stick to short- and medium-tenured bonds.

CREDIT RISK: Accrual funds take on credit risk by buying companies that have a weak credit rating but strong fundamentals.
The strategy is: if the company is as well-managed as they think it is, its credit rating is bound to improve at some point. This uptick in credit rating will push up its price and the fund benefits. But if the company suffers from a downgrade in rating, the fund can suffer badly.

REGULAR INCOME: Many advisers recommend fixed income funds as an alternative to bank fixed deposits (FDs) and suggest moving a portion of the FD corpus to debt funds. Here, accrual funds score as they invest in companies for the long-term and aim to capitalise on interest rate income that they earn. Duration funds aren’t meant for regular income and they typically tend to capitalise on events that unfold over a shorter time frame.

FIRST TIME INVESTOR: Accrual funds carry a bigger risk because a fund manager who goes wrong on her duration call can recover relatively faster than had she taken—and suffered from—a wrong credit call. Defaults and downgrades of companies can be devastating, as it not only leads to losses, but spreads panic that results in massive outflows. Accrual funds, therefore, may be bought as a topping and not part of your core portfolio.

Accrual and duration strategies serve their purpose for different goals and strategies. However, for a first-time investor, a duration strategy would be a safer bet.


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