Why SBI Corporate Bond gets a Neutral rating

By Morningstar Analysts |  27-04-18 | 
 

The fund’s investment team is highly experienced and adequately resourced, but the recent change in the portfolio managers, together with corresponding below-average returns despite a competitive expense ratio, underpin the fund’s Morningstar Analyst Rating of Neutral.

Following the restructuring of the fund, Dinesh Ahuja started managing the fund in July 2014; however, in January 2017, he stepped down to focus on duration strategies. Lokesh Mallya and Mansi Sajeja have been the portfolio managers since February 2017, and also continue to contribute as analysts.

With the strengthening of the credit research team after venturing into the credit space, we believe the team has the manpower to thoroughly cover the investment universe, but we need time to see how much of a fit the new portfolio managers will be, since they do not have experience in managing credit funds.

Under Ahuja’s leadership, the fund has successfully endured various market cycles, but under the new managers, the fund’s performance is yet to make a positive impact. The fund’s 3-year returns have been impressive, but it has delivered a lackluster performance on a 1-year basis, despite its highly competitive expense ratio.

The fund’s strategy

The fund's investment strategy is to take a significant credit risk while minimizing interest-rate exposure. They invest across the capital structure with a bottom-up investment process and apply a combination of quality and liquidity filters to the universe. This helps eliminate speculative companies with excessive debt or negative earnings.

Investments in credits are not based on interest-rate movements, reflecting its passive duration strategy. The team uses various qualitative and quantitative parameters and puts a lot of emphasis on the company's management, business, and financial health. They look into the covenants in-depth that protect them from downside scenarios.

They also use the analysis of sell-side research and credit rating agencies to form a view on the credit worthiness of companies but to a limited extent. The credit committee then reviews the rated securities and the approved securities are assigned credit and tenor limit.

Currently, the investment universe is composed of 320 companies. While constructing the portfolio, the managers have the flexibility to implement the trades with reasonable leeway to express their views. The risk-management team also periodically reviews the portfolio to ensure that the managers adhere to the guidelines.

Despite changes at the helm, the fund’s investment strategy remains consistent. The process is purely bottom-up with a focus on high-quality business models and maintaining a relatively more-liquid portfolio. The managers remain cautious on the lowest rated/unrated issues in order to avoid defaults. They are mindful about credit risk, but they are more cautious on liquidity risk and hence have put an investment cap of Rs 10 crores for a single folio.

We believe in the fund’s integrated investment process and the depth of knowledge that the team possesses; however, the change in guard and average execution so far limits our conviction.

The fund’s portfolio

The fund invests primarily in high-yielding fixed-income instruments to generate superior risk-adjusted returns over the short to medium term. With credit risk being higher in the portfolio, managers maintain lower duration risk in the range of two to three years. Hence, to maintain duration within the band, the manager avoids investing in government securities/state development loans and invests only in fixed-income securities below five years maturity.

The managers think that more than credit, it is liquidity risk which is critical, and therefore, 20%-40% assets are maintained in AAA rated bonds based on the credit cycle. However, recently the managers have found opportunities for a more aggressive stance to participate in the market upside and have raised the fund’s exposure to lower-rated bonds. Yet the fund has been conservative relative to peers, maintaining higher weighting to AA rated instruments than single A and lower-rated instruments. It is also well diversified, with around 60-70 securities, and each security’s limit is capped at 5%.

The managers invest across the capital structure than simply going down the credit curve. They have invested in some high-yielding structures backed by promoter guarantee, loan against shares, cash flows, and so on. For example: Shapoorji Pallonji Energy, SEI Enerstar Renewable Energy, SEI Baskara Power, Pune Solapur Expressways, and Essel Corporate Resources.

The fund’s performance

The fund’s long-term returns have been superior compared with its peers, but it has struggled in recent periods with the change in hands.

Given the current manager’s record so far, it’s a rather short time frame to draw any meaningful conclusion and hence we would closely watch how they would navigate through different market conditions going ahead.

Access details on SBI Corporate Bond fund here

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