Open-Ended Debt Funds, Fixed Maturity Plans & Nippon India Nivesh Lakshya Fund


To carry on where we left off with our previous post about money market funds, we’re now going to talk about the one single drawback to debt instruments, as well as the remedy. As we all know, debt instruments like corporate bonds, for example, decrease in value as prevailing interest rates go up. This is because when interest rates go up, people would rather put their money in banks than invest in bond funds at lower interest rates, causing the bonds to decrease in value. The inverse is also true here which means if prevailing interest rates fall, corporate bonds that were isssued before the fall, will increase in value.

Maturity roll-down

As we mentioned in our previous post on the money market, floating rate funds try to negate this effect by investing in bonds with interest rates that change in accordance with prevailing interest rates in the economy.  However, this is typically accomplished by increasing risk by investing in sub-par bonds and in some cases, debt that is close to junk status. This is why floating-rate funds are considered high-risk and definitely not for the cautious investors looking for high-quality corporate paper or government bonds. What then is the solution to reduce the risk of rising interest rates on debt instruments?


Now with money market funds in particular, we have open-ended funds and we have fixed-maturity funds, both of which are affected adversely by rising interest rates, the only significant difference being you can’t enter and exit any time in a fixed-maturity fund. Bringing you the best of both worlds, are Maturity Roll-down funds which give you a fixed-maturity period while still remaining open-ended. This serves two purposes, to give investors the predictabile returns of a closed-end fund, while also allowing the freedom to enter or exit on any business day. 

Using the yield curve

How does a fixed-maturity fund remain open-ended is the obvious next question here, the answer to which is the fact that the fund invests only in papers that match the remaining tenure of the fund. So for a 25 year fund where investments are made in corporate bonds with a duration of 25 years during the first year, during the second year investments will only be made in bonds that have 24 years remaining, and so on, and so forth till the fund reaches maturity. This is done without increasing risk like floating rate funds and is the reason why returns are more predictable. 


The next question, how does the fund achieve this without increasing risk? The answer, yield curves are always upward sloping so the longer the maturity, higher the yield. This is why holding a fund till maturity over a longer period of time is the best way to negate the effects of rising interest rates. Now let us assume you invest in a 25 year bond that’s currently trading at 6.7%, while a 20 year bonds is trading at 6.5%. What will happen after 5 years is that you will have a 20 year bond with an extra 0.2% yield which investors will be ready to pay more for. 


This is because an older bond with higher yield and is more valuable than a newer bond with lower yield having the same residual maturity. Additionally, since the duration of the bond reduces over time, so does the risk of rising interest rates. That being said, lets take a look at a new fund offering from Nippon India, that’s an open-ended, fixed maturity scheme with roll-down strategy.


Nippon India Nivesh Lakshya Fund 


Average Maturity: 24.06 years (as on 10th February 2021. Source: Nippon India Mutual Fund).

Modified Duration: 11.19 years (as on 10th February 2021. Source: Nippon India Mutual Fund).


Investment portfolio: This scheme predominantly invests in long dated Government Securities (25 to 30 years maturities). G-Sec is a lot safer than corporate bonds and a lot harder to invest in as an individual.


Yield: The current yield to maturity (YTM) of the scheme is 6.7% (as on 10th February 2021. Source: Nippon India Mutual Fund). 


Like we already discussed, since the scheme employs a maturity roll-down strategy, as the remaining tenure reduces, so does the interest rate risk, which will continue to reduce over the investment tenure.


Credit risk: The scheme only invests in Government Securities which means there is virtually no credit risk aince Government Securities come with a sovereign guarantee which means interest and principal payments are guaranteed by the Government.


Investing long-term

In conclusion, given the steepness of the curve at present, there’s really no substitute for investing long-term and holding on to high quality corporate or G-Sec funds till maturity. That being said, if you’re looking for good money-market products that offer all the features discussed in this post, particularly, products built with longer maturity and quality corporate or government papers, feel free to contact us for further details. Remember different player, different playing style, so don’t hesitate to contact us for a tailor made strategy to suit your risk-profile.

 

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