"Fixed" Income - The Case for Debt Passives - Radhika Gupta

A few weeks ago, I hosted a Twitter Spaces session on fixed income investing for retail investors. When the time came for Q&A, a young guy – all of 25-30 – asked me, how he should go about picking a debt fund. “I don't think I can invest in debt funds. I am not a bond trader,” he said. Around the same time, I had a conversation with a family friend who was looking to park money for 2-3 years, where capital safety was of utmost importance and wanted my urgent advice on debt funds. “I know how to choose between large cap and mid cap funds, but I don't understand the difference between short term and corporate bond funds,” she said.

Fixed income investing should be easy, but it isn't. Debt money is boring money, parking money, the kind you don't take risk on because you have equity for that. But throw in durations, yield curves, credit policy, inflation, and the Fed into the mix and it's no surprise the ordinary investor gets confused. Very few investors understand even basic bond concepts like duration, the best evidence of which is the number of queries we get on the few days debt funds are down because of a sharp rise in interest rates. We don't get that many queries when a small cap fund falls 4-5%! It makes sense: equity investors were brought up on an appetite of knowing companies and understanding markets, but debt investors are essentially FD investors who were used to a simple decision making process with very few variables. You have savings accounts for parking money, and you have FDs with different durations. Choose the tenor, pick the rate, and you are done. What the RBI does and where inflation goes doesn't matter, and your bank is not going to set you a view on debt markets for the tenor of your FD. It's simple and it's passive. When the Bharat Bond mandate gave our team at Edelweiss AMC an opportunity to launch India's first passive corporate bond fund, we spend months thinking about what the structure should be. Should we create a passive equivalent of short-term funds, should we create a mixed duration version of the dynamic bond fund, should we create a gilt fund equivalent? After studying many global models, we finally chose the target maturity (TM) fund, an open-ended passive fund that had a targeted date on which it matured, like 2026 or 2027. These funds bought bonds of a certain rating / issuer quality maturing in a certain year and held them till maturity. Because they had a defined maturity, their yield was one, known upfront, and two, reasonably certain if an investor stayed till maturity. In doing so, they provide an experience that mirrors that of an FD or bond packaged with the liquidity and tax efficiency of an open-ended debt mutual fund. Cut to today, two years after the Bharat Bond launch, debt passives are a 40,000 crore business for Edelweiss AMC, and 8-10 AMCs have either filed or launched target maturity debt passive funds.

Now passive is not an unfamiliar word and there isn't a day when I am not asked about the “active vs. passive”. Passive has always, in the Indian context, however, alluded to equity, in the context of disappearing alpha. While that debate over alpha in equities can continue well beyond the word-count of this article, if there is one asset class that is suited for passive, it's fixed income. For one, in fixed income, consumers care about simplicity, the number one benefit of passive funds. Very few debt investors even think about or track if their fund beats a bond index! Secondly, costs matter more in fixed income, where 10 bps count, particularly in a low interest rate regime. And finally, if we dig into the fixed income products that have been successful in mutual funds, they happen to be passive – FMPs that were closed ended buy and hold funds, and rolldown funds (buy and hold strategies usually run in existing open ended funds). The flexi-cap equity equivalent in bond funds, the dynamic bond category which has an active mandate is small in size.

When the Bharat Bond mandate gave our team at Edelweiss AMC an opportunity to launch India's first passive corporate bond fund, we spend months thinking about what the structure should be. Should we create a passive equivalent of short-term funds, should we create a mixed duration version of the dynamic bond fund, should we create a gilt fund equivalent? After studying many global models, we finally chose the target maturity (TM) fund, an open-ended passive fund that had a targeted date on which it matured, like 2026 or 2027. These funds bought bonds of a certain rating / issuer quality maturing in a certain year and held them till maturity. Because they had a defined maturity, their yield was one, known upfront, and two, reasonably certain if an investor stayed till maturity. In doing so, they provide an experience that mirrors that of an FD or bond packaged with the liquidity and tax efficiency of an open-ended debt mutual fund. Cut to today, two years after the Bharat Bond launch, debt passives are a 40,000 crore business for Edelweiss AMC, and 8-10 AMCs have either filed or launched target maturity debt passive funds.

And while passive strategies have existed in mutual funds, via FMPs and rolldown funds, the target maturity framework makes communication and decision making a lot easier. Index yields and portfolios are known upfront – unlike an FMP, and the strategy and maturity year is defined and written in stone. When an investor buys a PSU-SDL 2026 debt index fund, they know they are getting a basket of PSU and SDL bonds maturing in 2026, at a yield in line with the index yield if they hold till 2026. And when a ladder of these products from 2023 to 2031 is available, an investor can build a complete debt portfolio depending on their cash flow needs.

In 1968, in a totally different world of Olympics, the high jump changed forever, when Dick Fosbury challenged conventional techniques and landed head-first in a back-layout style jump. Since then, most everyone who has set any kind of record in high jumps has used the “Fosbury flop”. The Indian consumer has always loved the mantra, “kitna deti hai?” and in the case of fixed income, add, “kitne time mein?” In being able to answer these two questions, target maturity funds may just make fixed income investing a little more fixed and give it a Fosbury flop moment.

Disclaimer: Ms. Radhika Gupta is the MD & CEO of Edelweiss Asset Management Limited (EAML) and the views expressed above are her own.