Accrual Based Funds Vis-a-Vis Duration Based Funds

In continuation of our earlier story on Debt Funds- Stay Invested! We would like to bring another fact for your understanding on Debt Funds. The Debt Funds are far more tax efficient, if held for three years or above, than any other fixed return product like Bank/Corporate FD, NCDs, Perpetual bonds etc available in the market. However, debt funds do not have a fixed coupon rate as compared to the above mentioned fixed return products. This is because of its inherent feature that the assets it possesses though have coupon rate but they are subject of mark to market, thus NAV is announced on daily basis for the investor to enter and exit as and when they wish to. It is important to understand that there are two categories of Debt Funds- Duration Based Funds and Accrual Based Funds, in the last few years Accrual Based funds have been more popular with the investors than Duration Based Funds as the later is more volatile than the former. All the debt funds have two components to give returns- Capital gains and Interest accrual. Capital gain arises due to fluctuation in interest rates depending on the average maturity of the papers and accrual of Interest depends on YTM of papers it is holding. See table below

Fund Name	Avg. Maturity (In Yrs)	YTM
Accrual Funds
Aditya Birla Sun Life Credit Risk Fund  - Growth	1.65	10.35
Franklin India Credit Risk Fund - Growth	2.43	10.92
ICICI Prudential Credit Risk Fund - Growth	1.9	9.67
Kotak Credit Risk Fund  - Growth	3.02	9.75
Reliance Credit Risk Fund - Growth	2.34	10.35
Duration Funds
Aditya Birla Sun Life Income Fund  - Growth	3.68	7.35
HDFC Income Fund - Growth	5.66	8.19
Kotak Bond Scheme  - Growth	3.75	8.24
Reliance Dynamic Bond Fund - Growth	7.61	8.09

* Data as on June 2018

Duration Based funds work more on strategy of capital gains than interest accrual thus holds papers with a high maturity which is currently around 5-8 years targeting capital gains arising due to any fall in interest rates. Whereas, Accrual based fund targets more on high interest rate coupon  giving portfolio higher YTMs which is around 9.5-10 than on duration of the portfolio (currently around 1-3 years). This is the reason that Duration Based Funds witness more volatile returns than Accrual Based Funds and investors in Debt Funds do not prefer to see volatile returns in portfolio. Accrual Based Funds held for 3-5 years not only would give investors 100-150 basis higher returns than bank FDs but would also give investors with highest tax slabs 2-5% p.a. post tax returns more than any fixed return product.

	Debt Fund	Bank Deposits
Amount of Investment (Rs.)	10000	10000
Post Expenses Yield (p.a)* (CAGR)	8.50%	6.70%
Tenor (in days)	1096	1096
Amount at the end of investment period	12,776	12,150
Gain	2,776	2,150
Indexed Cost#	11,659	NA
Indexed Gain/ (Loss)	1,117	NA
Tax Rate$	23.60%	30.90%
Tax	264	664
Post Tax Gain	2,512	1,486
Total Amount Realised	12,512	11,486
Post Tax Annualised	8.37%	4.95%
Post Tax CAGR	7.75%	4.72%
Post Tax Absolute	25.12%	14.86%

*Indicative Returns for Debt Funds and FD Rates of SBI as on August 2018. ^#Indexation Assumed at 5.25% p.a. ^$Tax Slab of 30% assumed.

As can be seen in the illustration above, higher slab rate individuals would witness a higher gap in the returns of debt funds and bank deposits as debt fund returns are liable for Long Term Capital Gain Tax after 3 years which is 20% after indexation benefit whereas fixed deposits and other such products give an interest which is entirely taxable as per tax slab of the investor. Thus, to ‘STAY INVESTED’ in debt funds is certainly beneficial for investors who have patience and would not panic with short term volatility to reap benefits of long term.

Disclaimer
Mutual Fund Investments are Subject to Market Risks. Please read the offer document carefully before investing.