Think Debt: Advisor Insights

Practical 5 step top-down approach in selecting debt funds

Harmik Singh Sachdeva, Milestone Financial, Ahmedabad.

Milestone Financial's Harmik Singh Sachdeva discusses his firm's approach towards debt funds, their 5 step top-down process for selecting debt funds and how they position debt funds within client portfolios. Milestone, which was founded by 4 friends in 2007 when they took an entrepreneurial plunge after serving a financial services company, has emerged as one of Ahmedabad's leading advisor firms, serving over 700 families, with an AuM of over Rs.240 crores, around half of which is in debt funds.

Team Milestone Financial, Ahmedabad

Fund selection in the debt space

We follow a 5 step top-down approach in selecting funds in the debt space:

1. Fund House experience: We place a lot of emphasis on the overall experience of the fund house in managing debt schemes. We typically consider only those fund houses which have been in this segment for at least 7-10 years, and where we can see good consistency in performance over long periods of time.

2. Fund Manager and fund management process: We prefer longevity in fund managers. When you have the same manager managing the fund for at least the last 5 years, you are able to understand performance in different market conditions a lot better and have a clearer appreciation of what you can expect from him going forward. Fund management processes are also very important - we like to see well documented processes that are strictly followed by all fund managers - processes are a safety net when fund managers move jobs.

3. Fund house philosophy: We prefer fund houses that clearly articulate their philosophy in the debt space, and who stick to that philosophy through different market conditions. There are fund houses that are very clear that they will not for example go into lower rated papers at all, and they stick to that. There are those who clearly articulate that they will go selectively into lower rated papers, and demonstrate their superior credit research in that space. What is important for us is to have clarity on the fund house's philosophy, to enable us to decide which philosophy suits our clients. Not having a well-articulated philosophy reduces confidence in the fund house.

4. Current portfolio: This is of course of paramount importance.

5. Expense ratio: We prefer funds that operate at industry average expense ratios within each product. Expense ratios that are above average are not in our clients' best interests.

Approach towards accrual funds

We believe accrual funds are ideal for individual investors, and have been making a conscious attempt to add them into the goal based solutions that we offer our clients. Accrual funds are ideally suited for goals that are short and medium term in nature. They are also good long term solutions for conservative investors.

Our experience suggests that investors have very reasonable expectations from accrual funds. If they can get 2% more than the current bank deposit rates, they are happy. And those who hold these funds for more than 3 years, enjoy considerable tax benefits, which effectively almost doubles the pre-tax equivalent return, when compared to bank deposits. Clients are very happy with such an outcome. We believe fund houses are doing a good job in managing accrual funds, and are broadly delivering well against client expectations.

Recent events in this segment has reiterated for us the need to strengthen due diligence on the diversification aspect in accrual funds - diversification across holdings and diversification of investor base. Regardless of portfolio quality, too much concentration is never a good thing.

Approach towards duration funds

Our belief is that duration funds are not suitable for retail investors. They are tactical investments by nature, as the main investment argument centres around bets on when and by how much interest rates will decline. For clients who want to participate in this segment, we prefer dynamic bond funds, which retain more flexibility in investment strategy. At this point of time, we recommend dynamic bond funds for clients who have the required risk appetite. But, maybe a year later, once interest rates have come down, we may take them off our recommended list. This segment is tactical, and not evergreen like accrual funds.

When clients express an interest in this segment, we try to manage their expectations on returns. We tell them that it is possible that for 6-8 months after they invest, they may see very little returns, and then a sudden spike in returns around the time of a rate cut. Clients need to understand that the returns stream from these funds will be choppy. Managing client expectations in this segment is very important.

Road ahead

We believe there is substantial scope for including debt funds within goal based solutions that can be offered to clients. We have begun a serious effort in this direction, and results are very encouraging. But a lot more needs to be done, especially in discussing short and medium term goals and offering appropriate debt funds for these needs.

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