HDFC Income Growth is a 4-star fund that falls in Morningstar’s ‘Intermediate Bond’ category. Managed by Shobhit Mehrotra, the fund has recently put up some good numbers. Its YTD is an impressive 11.57%, way above the category average of 6.75%.
Senior research analyst Nehal Meshram takes a look at the fund and explains why it merits a ‘Neutral’ analyst rating.
The fund manager’s assessment of inflation, money supply, private sector and government borrowings, fiscal and monetary policy, and domestic and global interest-rate scenarios leads to the selection of a duration target. In addition to duration management, yield-curve positioning and interest-rate direction call forms the basis of portfolio construction.
The fund is aggressively managed and duration varies between 5 and 8 years. Historically, the fund has not gone too below the duration curve as compared with its peers as the fund manager has stuck to the fund’s investment mandate.
True to the team’s philosophy of building a liquid portfolio, the fund maintains an 80%-90% allocation in G-Secs and highly liquid AAA rated corporate bonds and the balance in sub-AAA-rated bonds and money market instruments.
When buying paper, the team focuses on factors such as the company management, financial strength of the promoter group, and corporate governance standards. This is followed by rigorous quantitative analysis such as leverage, coverage, and solvency ratios.
The investment in sub-AAA-rated bonds is mainly in companies in which the investment team has a high degree of conviction with strong management and financial strength such as Hindalco, Tata Power, and Tata Steel. Mehrotra has also started adding to the portfolio a few public sector undertakings bonds on the expectation that the worst has passed in terms of bad loans.
The fund has years of impressive performance (2010, 2014) as well as years of underperformance (2011, 2013, 2015).
Under Mehrotra’s tenure (September 2007-June 2016), the fund returned 8.3% against 8% of its Morningstar Category average. The risk profile (represented by its standard deviation) has been higher than its peers across all time frames. The reason behind this is the fund’s longer average maturity than peers, which has made the fund more sensitive to interest-rate fluctuations. The fund has been able to deliver returns commensurate to the risk taken on a one- and two-year basis (ended June 2016), positioning in the first quartile in terms of its performance by outpacing 79% and 77% of its peers, respectively.
The manager's decision to add duration in these years subsequently buoyed those returns as bonds rallied with cuts in interest rates by the Reserve Bank of India. However, this strategy did not work over a 5-year period, and there was an impact on returns caused by periods when yields were hardening.
Why the fund has a ‘Neutral’ rating.
Though a highly experienced manager adopts a time-tested investment approach, it could not hold our conviction.
The overall approach has not generated steady returns. The fund had to withstand many jolts because of its higher maturity holding as compared with its peers across time frames. On a risk-adjusted basis, the track record over 3 and 5 years is lower than the Morningstar Category average.
We also see the disadvantages of its high fees, which impede the performance. At 1.92%, the fund’s expense ratio is higher than the category median (1.68%). This puts the fund in the eighth decile, making it one of the expensive funds in its category.
