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Income opportunity funds give better returns when interest rate is falling
Published On , 12 Jul 2016 By Times Of India
For most investors, Debt funds are usually considered to be low-risk investment options. This may be true for some of the Debt funds under normal market and economic conditions, there are some Debt funds also which are structured in such a way that they are for those investors who, even while remaining invested in the fixed income segment, prefer to take higher risks.
Among such Debt schemes which carry higher risk than the others are the income opportunities funds. At times these funds are also called credit opportunities funds, corporate Debt opportunities funds, corporate bond opportunities funds etc.
HOW THESE FUNDS WORK?
At the very basic, the rate of interest (also called yield) that you can get by investing in a bond is inversely proportional to its price. For example, you invest in a bond at Rs 100 that gives 11% yearly rate of interest. After a year, you get Rs 11 as interest on that bond. Also the price of that bond in the market rises to Rs 110 and you sell it. For the new buyer, who will get Rs 11 at the end of the next year, the yield will be 10% while for you, the first holder it was 11%. So here since the price of the bond has risen the yield has fallen. The reverse is also true. If the price of the bond falls to Rs 90, the yield will be about 12.2%.
HOW FUND MANAGERS PLAY THIS INVERSE RELATIONSHIP?
Suppose a fund mana g e r for an income opport u n i t y scheme holds corporate bonds in his/her portfolio. After a few months he/she sees that some of the companies in his/her portfolio are expected to do better in their lines of business and some are expected to do badly. So there is a chance that the bonds of companies which are expected to do better are likely to see a rise in price while bonds of those which are expected to do badly will see a slide in prices. So the fund manager would probably sell the bonds of companies which are expected to do badly and buy more of those which are expected to do better.
This way, after a while if the bond prices of these corporates move as expected, the scheme would also perform better. A better corporate performance also leads to higher credit rating and a lower yield for such bonds since Debts with higher ratings are always in more demand than the ones with lower ratings. This kind of strategy is also called the credit play. However, the risk lies in the fact that in case the bond prices do not move as expected.
WHO COULD INVEST IN THESE FUNDS?
According to a top official at a domestic mutual fund, it depends on the risk-taking ability of an investor. "If the risk profile matches, one could invest about 20-30% of the total Debt portfolio in these funds," said the official. "In such funds, the investors need to look at the fund portfolio and analyse the kind of exposure the fund manager has taken in papers which are rated 'A' or 'A+' and so on. These papers are more likely to get an upgrade and bring in higher profits for investors," the official said.
WHEN TO INVEST IN THESE FUNDS?
These funds give better returns when the interest rate cycle in on a downturn, like the one now. In the last one and half years the RBi has cut the policy rate by 1.5 percentage points and more is expected. However, financial planners and advisors warn that since these are slightly more specialized schemes, so you should not rush into investing in these funds without proper guidance.
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