Balance And Stability - Investing in Debt Funds

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This booklet seeks to explain why debt funds should form an integral part of your asset allocation.

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Balance And Stability - Investing in Debt Funds

  1. 1. Balance&Stability Presented by Debt funds can add balance and stability to your portfolio. Find out more on how to make the best use of this asset class The content for this booklet has been developed and designed exclusively for Franklin Templeton Investments by Money Today, a part of the India Today Group (Living Media India Ltd.)
  2. 2. Contents 3 Debt funds can add stability to your overall portfolio Over time, debt funds can be rewarding invest- ments Debt funds invest in a variety of debt instruments Why Invest in Debt? Traditionally, debt mutual funds (also known as fixed income mutual funds) have not been as popular as equity mutual funds. Though not much talked about generally, debt funds can actually offer several advantages over traditional fixed income instruments while also helping you balance your equity exposure. This booklet seeks to explain in simple, easy to understand language the benefits of adding debt mutual funds to your investment portfolio. 4 Why Invest in Debt? Learn how adding debt funds can add stability to your overall portfolio 6 Understanding Debt Funds Debt funds offer several advantages to the investor over bonds and FDs 10 How to choose the right debt fund? With so many options available, we help you get it right 13 Two performers for your portfolio Presenting Templeton India Short Term Income Plan (TSTIP) and Templeton India Income Opportunities Fund (TIIOF) Design: SANJIT
  3. 3. Role of debt in your portfolio Debt investments provide an assured stream of income, which lends stability to the portfo- lio. It also helps investors take calculated risks. The knowledge that a portion of his investment is safe and generating income allows the individual to invest in volatile but potentially rewarding assets such as equities. Indian investors are traditionally risk averse and almost 55% of total household savings are parked in debt instruments. Stocks account for a minuscule 2.75%. Given the risk aversion, it’s not surprising that bank deposits are the most popular fixed income option in India. What is surprising, however, is that though other fixed income options offer several benefits, retail investors have stayed away. Debt funds are tax efficient, offer greater flexibility and could give higher post-tax returns than FDs (though they can- not guarantee returns like FDs). Yet, retail investors have a minuscule investment in debt funds compared to the money parked in FDs. Debt investments can lend stability to a portfolio and help investors balance the gut-wrenching volatility of equities Why Invest in Debt Rising share of household savings The largest chunk of household savings is parked in bank deposits. 4 5 A debt instrument (also known as a fixed income instrument or bond) is issued by a corporate, institu- tion or government and promises a fixed interest payment (the coupon rate) on a regular basis and the return of the original investment at a set date (the maturity date). Unlike investing in stocks where you become an owner, when you buy a debt instrument, you become a lender. 55% of total household savings in India are parked in the safety of bank deposits. Only 2.6% is allocated to equity Balance to Volatile Assets Equities are inherently volatile as evi- dent from the table below. Debt funds can help balance the volatility Source: BSE Source: RBI 4,20,000 3,00,000 1,80,000 60,000 Currency RsCrore Bank deposits Non-banking deposits Life insurance PPF and pension funds Shares and debentures 22,000 18,000 30,000 26,000 14000 10000 6000 2000 May ’00 May ’06 May ’10 2005-06 2006-07 2007-08 2008-09
  4. 4. 6 7 W hile in the case of equity mutual funds, the underly- ing investment - equities - is relatively easy to under- stand given that the move- ment in share price is what an investor can usually track, in case of debt mutual funds too it is not as complicated as it may look. Let us take you through the basics. What is a debt fund (or a fixed income fund)? A mutual fund that invests in debt or fixed income securities issued by various corpo- rates, institutions and government is known as a debt fund or a fixed income fund. The main investing objectives of a debt fund will usually be preservation of capital and gener- ation of regular income. Therefore, a debt mutual fund is typically made up of a number of bonds or fixed income instruments care- fully selected by the fund manager. Why invest in debt funds? There are multiple reasons why you should consider debt funds as an integral part of your overall investment portfolio. Debt funds offer several advantages over bonds and fixed deposits. These funds have higher liquidity, are more tax efficient and have the potential to give superior returns. Understanding Debt Funds Asset Allocation: Based on your age and risk profile, debt funds should form a strategic portion of your overall asset allocation plan. The thumb rule usually is to have a debt allo- cation equal to your age. For example, if you are 35 years of age, your overall asset alloca- tion could be 35% debt and hence 65% (100- 35) to equity. Though this could change indi- vidual to individual. Regular income: Most debt funds seek to pay regular dividends (though dividend is not assured and is subject to availability of distrib- utable surplus) Lower volatility: Historically, debt / fixed income funds have been less volatile as com- pared to equities. Diversification: Since equities and debt don't usually move in tandem, debt funds can provide balance to your portfolio especially during periods of poor stock market perform- ances. Further, debt funds typically hold a number of individual papers - poten- tially reducing the impact of a decline in any one holding. Benefit of professional management: Fund man- agers actively analyze macro and micro economic data, mar- ket conditions as well as indi- vidual securities thereby pick- ing up the best options for build- ing a quality debt fund portfolio. Tax benefits: Debt funds are typi- cally more tax efficient than fixed deposits and other fixed income instruments where one has to pay tax at the marginal rate as per the tax bracket one is in. However, debt funds do not offer any assured returns. Convenience and flexibil- ity: Debt funds are also very flexible. In fact, in most cases, you can make further additions or redeem the investments at will (subject to the applicable exit loads). You can also start systematic withdrawal plans (SWPs) for meeting your monthly expenses or systematic transfer plans (STPs) into other mutual funds. HOW YOU CAN EARN RETURNS FROM DEBT FUNDS Debt funds are fixed income instru- ments, meaning their attraction is the endeavour to generate steady income. Debt funds earn income primarily in two ways: Income from accrual: The appeal of most bonds is steady income. Bond holders can usually expect to receive regular, fixed-interest payments until the bond matures, at which point principal is returned. Income from duration/capital gains: Prior to maturity, the market value of bonds may rise or fall depending on market conditions. Investors could real- ize a capital gain or a loss by selling a bond before maturity.
  5. 5. 8 9 but these funds are not immune to inter- est rate movements. G-Secs come with a wide range of maturities, from a few days to 30 years, so many gilt funds have short term and long term plans. The tenure of the gilt fund is an impor- tant factor that defines its suitability for the investor. Income funds: These are typical- ly diversified debt funds that invest in a mix of corporate bonds and government securi- ties. They invest in securities across the yield curve, with the sole purpose of utiliz- ing any opportunities provided by factors like inflation, changes in liquidity, changes in mon- etary policy or government borrowing pro- gram. Income funds also tend to use the inef- ficiency and volatility in the debt market to get better returns. Fixed maturity plans: These funds are focused on the accrual strategy of investing in debt. They buy debt securities and then hold them till they mature and are close ended in nature meaning you cannot exit or enter in between. This ensures a steady and stable income for the fund without any upward or downward spike due to change in interest rates. Fixed maturity plans are suitable for investors who want stable (though not assured) returns from their debt fund invest- ments. These funds are now listed on stock exchanges to facilitate selling and buying before maturity. Types of Debt / Fixed Income Funds Debt funds invest in a wide range of fixed income securities and therefore there are several categories of such funds. The catego- ry is defined by the type of debt instruments in which the fund invests and the average maturity of the securities in its investment portfolio. Some funds are focused on accrual and earn from the accumulation of the inter- est from their holdings. For others, the objective is to gain from the rise in value of long-term bonds due to changes in the inter- est rates. Here are some of the major types of debt funds and where they invest: Liquid funds: Any investment that can be sold off easily to raise cash is defined as a liq- uid investment. Money market funds, or liquid funds, are one of the safest places to park your money for the short term. These funds invest into money market securities and debt securi- ties that mature in 2-3 months. Most corpo- rates park their short term money into these funds. For individual investors, liquid funds offer greater tax efficiency than a savings bank account. The primary objective of these types of funds is typically capital preservation. Ultra short-term funds: These funds primarily invest in money market instruments and are meant for investors who wish to park their money for a few months. These funds tend to generate better returns than liquid funds though at higher levels of risk. Floating rate funds: Floaters invest into floating rate debt securities. Most of the debt securities in a floater fund mature within a year. These funds are not very sensitive to interest rate changes. But this also means that floating rate funds do not gain from any downward change in interest rates. When interest rates are expected to rise, floaters are better debt investments than other debt funds. These are suitable for investors who don't want to subject their money to interest rate risks. Short-term funds: These funds invest in debt securities that mature over the next 12-18 months. The quality of bonds in which they invest defines their returns. Short term funds are best suited for investors with an invest- ment horizon of 6 to 18 months. Gilt funds: Gilt funds invest exclusively in debt securities issued by the Central or state governments. There is no risk of default with G-Secs because of the sovereign guarantee, Liquid Funds < 3 Months 3 Months to 1 Yr > 1 Yr Funds focused on accruals Short Term MFs Funds focused on duration Short Term Income Funds Floating Rate Funds Risk/Returns Gilt Funds Long Term Income Funds Investment Horizon Fixed Income Mutual Funds- Wide range of products
  6. 6. 10 11 T he single most important thing to do is to choose a leading fund house with a solid reputation. This could be the difference between a steady income and added pressure on your portfolio. Ask the following questions before investing: Does the fund house have a long track record and expertise in man- aging investor money? Because firms that have managed mutual funds over several years of changing financial markets are more seasoned and experienced, potentially making them better equipped to manage the ups and downs of economic cycles Does the fund house have a strong research team? Because mutual funds with extensive research capabilities may be better posi- tioned to uncover value and opportunities in the fixed income markets Does the fund house have a broad range of funds to choose from? Because a large selection of funds may make it easier to customize your portfolio to your individual financial goals and risk tolerances Apart from this, you also need to consider the following factors while choosing a fund: Match the Duration Choose a fund that matches your investment tenure. Don't buy a long-term fund if your investment is for only two months. How to choose the right debt fund?With so many debt funds and fund houses to choose from in the market, how do you decide where to invest? Here is a quick check- list you need to consider before investing: Long-term funds tend to be more volatile than short-term funds because of the interest rate risk they carry. If the interest rates sud- denly shoot up, the NAV of you debt fund could plummet. This could pose problems if you need the money in the very short term. A short-term income fund or a liquid fund could give you the stability you are looking for. On the other hand, don't opt for short- term funds if you intend to stay invested for 1-2 years. A medium-term income fund will be more suitable for the purpose. If you are wary of changes in the interest rates, opt for a floating rate fund since they are not sensi- tive to interest rate changes. Also check the exit loads applicable on the redemption of the investment. Some debt funds slap very high exit loads if the invest- ment is redeemed before a specified term. Compare Returns and Risks Check the returns earned by the fund in comparison to its peers. An underperform- ing fund is obviously not a good choice but one should not blindly invest in an outper- former. It could be that the fund is generat- ing higher returns by investing in low quali- ty debt instruments. For instance, a low- rated corporate bond will offer a higher rate of interest than an AAA rated instrument. But if the issuer fails to repay the amount on maturity, the fund would be saddled with heavy losses. This is the credit risk that debt funds face. Check out the quality of the fund’s holdings before investing.
  7. 7. 12 13 W hy does it make sense to invest in these two prod- ucts? An analysis of the current market (and eco- nomic) environment will illustrate the need. Current Market Environment In recent months, RBI has indicated that it is ready to take aggressive steps in order to bring a balance between inflation and growth. The recent hike in the repo and reverse repo rates was in line with expectations. While eco- nomic growth has been high, the rising inflation has continued to weigh on market sentiment with the Wholesale Price Inflation (WPI) reaching double digits in recent times. It is anticipated that borrowing cost may also rise in the near future due to tight liquid- ity conditions. On the other hand, improve- ment in economic growth momentum along with benign financial mar- ket conditions has helped Indian companies post strong earnings growth. It is expected that this trend will be sustained in the com- ing quarters. However, concerns about glob- al recovery and domestic rise in key policy rates have led to increased volatility in the yields. Given the current environment, investors should look at investing in a fund that can generate superior returns while being relatively less affected by interest rate hikes. Accrual products can help minimize this interest rate risk and strive to generate higher yields as they follow a buy and hold strategy. As mentioned earlier, returns on such products are less affected by inter- est rate risk over the long term. Based on your investment horizon, you may choose to invest either in Templeton India Short Term Income Plan (TSTIP) or Templeton India Income Opportunities Fund (TIIOF). Presenting the Templeton India Short Term Income Plan (TISTIP) and Templeton India Income Opportunities Fund (TIIOF), two top performers from Franklin Templeton Investments. Two Performers for your PortfolioInterest Rate Bond Prices While we have spoken about the advantages of investing in debt funds, there are also risks associated with fixed income instruments. Interest Rate or Duration Risk: Duration or Interest rate risk is the risk that interest rates may rise, causing a fall in value of traded bonds and hence lower returns (and also cap- ital erosion) Liquidity Risk: This is the risk that a bond holder may not be able to access money quickly or without cost when needed. Besides limiting portfolio management options for fund managers, this can distort pricing. As a result, we see a situation where there are two yield curves–one for liquid paper and another for the illiquid kind. The latter, obviously, tends to quote at a discount. Credit Risk: Credit risk is the risk that the issuer will not pay the coupon income and/or maturity proceeds on the specified dates. This could also lead to capital erosion of the scheme’s portfolio. Understanding Interest Rate / Duration Risk Bond prices and debt fund NAVs have an inverse relation with interest rates. If rates go down, the value of bonds and NAVs go up. A bond with a coupon rate of 8% will become attractive to investors if the bench- mark rate falls to 6%. The reverse happens if interest rates go up and the 8% bond will not find takers if the prevailing interest rises to 9%. This impact of change in rates is more for longer duration bonds. That is why short-term debt funds are not as volatile as funds that hold bonds of longer maturities. But this also means that returns earned by short-term funds are lower than those of medium and long- term funds. However, a fund can mitigate this- risk by focusing on an accrual strategy. In the following pages we look at two funds that follow this strategy. These funds are from the largest foreign fund house in the country and one of India's oldest asset man- agement company with an investment track record of over 16 years - Franklin Templeton. Risks associated with investing in debt funds Interest rates and bond prices are inversely related
  8. 8. 13 W hy does it make sense to invest in these two prod- ucts? An analysis of the current market (and eco- nomic) environment will illustrate the need. Current Market Environment In recent months, RBI has indicated that it is ready to take aggressive steps in order to bring a balance between inflation and growth. The recent hike in the repo and reverse repo rates was in line with expectations. While eco- nomic growth has been high, the rising inflation has continued to weigh on market sentiment with the Wholesale Price Inflation (WPI) reaching double digits in recent times. It is anticipated that borrowing cost may also rise in the near future due to tight liquid- ity conditions. On the other hand, improve- ment in economic growth momentum along with benign financial mar- ket conditions has helped Indian companies post strong earnings growth. It is expected that this trend will be sustained in the com- ing quarters. However, concerns about glob- al recovery and domestic rise in key policy rates have led to increased volatility in the yields. Given the current environment, investors should look at investing in a fund that can generate superior returns while being relatively less affected by interest rate hikes. Accrual products can help minimize this interest rate risk and strive to generate higher yields as they follow a buy and hold strategy. As mentioned earlier, returns on such products are less affected by inter- est rate risk over the long term. Based on your investment horizon, you may choose to invest either in Templeton India Short Term Income Plan (TSTIP) or Templeton India Income Opportunities Fund (TIIOF). Presenting the Templeton India Short Term Income Plan (TISTIP) and Templeton India Income Opportunities Fund (TIIOF), two top performers from Franklin Templeton Investments. Two Performers for your Portfolio Templeton India Short Term Income Plan (TISTIP) Suitable for investors with an investment horizon of at least 6 months Templeton India Income Opportunities Fund (TIIOF) Suitable for investors with an investment horizon of at least 18 months TISTIP is an open-ended short term income fund that focuses on short-term corporate bonds to help investors weather uncertain debt market conditions. The fund endeavours to maintain a higher exposure to investment grade securities as part of the strategy to minimize credit risk. With a low maturity profile and higher allocation to corporate bonds, the fund has been able to deliver consistently since inception. The fund is ideal for investors having a conservative risk profile and an investment horizon of 6 to 18 months. TIIOF is an open end income fund that seeks to focus on high accrual with the flexibility to take higher exposure to a particular security class. It invests in securitized debt like PTCs that provide a yield premium at relatively low default rates. It is a retail focused fund with limitations on large inflows/ outflows to increase efficiency to deliver better returns such as higher exit loads and cap on maximum investment application per day. The fund is ideal for investors having conserva- tive risk profile and investment horizon of 18 months and above. What is more, you can start investing in these funds with as little as Rs. 5000. So start today and take the first step to building a quality portfolio. P 8.61%7.69% 9.48% 7.03%6.70% 7.23% 4.92% 6.96% 3.78% Past performance may or may not be sustained in future. *Returns for TISTIP Retail Plan are compounded and annualized returns based on 29.09.2010 Growth Plan NAV of Rs. 1900.6163. Returns for TIIOF are absolute based on 29.09.2010 Growth Pan NAV of Rs. 10.6957. Inception date: TISTIP - Retail Plan: 31.01.02 and TIIOF: 11.12.2009. Dividends are assumed to be reinvested and Bonus is adjusted. Load is not taken into consideration. Since inception returns of Crisil Short Term Bond Fund Index not available for TISTIP Retail Plan. Scheme Classification and Objective: Templeton India Income Opportu- nities Fund (TIIOF) is an open-end income scheme which seeks to provide regular income and capital appreciation by investing in fixed income securities across the yield curve. Templeton India Short-Term Income Plan (TISTIP) an open-end income scheme with an objective to provide stable returns by investing in fixed income securities. Load Structure: TIIOF: Entry Load: NIL; Exit Load: 3% if redeemed within 6 months from the date of allotment, 2% if redeemed after 6 months but within 12 months from the date of allotment, 1% if redeemed after 12 months but within 18 months from the date of allotment. TISTIP: Entry Load: NIL; Exit Load: 0.50% if redeemed within 6 months from date of allotment. Risk Factors: All investments in mutual funds and securities are subject to market risks and the NAV of the scheme may go up or down depending upon the factors and forces affecting the securities market including the fluctuations in the interest rates. There can be no assurance that the scheme's investment objectives will be achieved. The past performance of the mutual funds managed by the Franklin Templeton Group and its affiliates is not necessarily indicative of future performance of the scheme. The above are only the names of the schemes and do not in any manner indicate the quality of the schemes, their future prospects or returns. The Mutual Fund is not guaranteeing or assuring any dividend under the scheme and the same is subject to availability and adequacy of distributable surplus. The investments made by the schemes are subject to external risks. Please read the Statement of Additional Information and Scheme Information Document carefully before investing. Statutory Details: Franklin Templeton Mutual Fund in India has been set up as a trust by Templeton International Inc. (liability restricted to the seed corpus of `1 lac) with Franklin Templeton Trustee Services Pvt. Ltd. as the Trustee (Trustee under the Indian Trust Act, 1882) and with Franklin Templeton Asset Management (India) Pvt. Ltd. as the Investment Manager. The Fund offers NAVs, purchases and redemptions on all business days except during the period when there is a book closure. TISTIP Retail Plan (Gr) CRISIL SHORT TERM BOND FUND INDEX (CSTBFI)

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