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Understanding Accrual Mutual Funds: A Comprehensive Guide
As interest rates experience another downturn, investors in debt mutual funds are reassessing their strategies, contemplating a shift from accrual funds to duration funds. However, recent credit downgrades have introduced complexities into various categories of accrual funds, complicating decision-making.
What Are Accrual Mutual Funds?
Accrual mutual funds employ a specific investment strategy aimed at generating returns. Fund managers invest in corporate bonds with higher coupon rates and hold these bonds until maturity to secure stable income. These funds often target bonds with lower credit ratings, which offer higher yields to maximize returns.
Accrual mutual funds encompass a range of categories, including liquid funds, ultra-short duration funds, corporate bond funds, credit risk funds, and fixed maturity plans (FMPs).
In contrast, duration funds employ a strategy where fund managers adjust the portfolio’s duration based on anticipated interest rate movements. In periods of declining interest rates, managers may invest in longer-term bonds to benefit from rising bond prices. Conversely, during rising interest rate environments, they may opt for shorter-term bonds to mitigate potential losses. Categories such as dynamic bond funds, gilt funds, and long-duration funds operate under this approach. Typically, accrual funds maintain an average portfolio maturity of 1-3 years to minimize risks associated with interest rate fluctuations.
Why Accrual Funds Matter
Accrual funds, known for their buy-and-hold strategy, tend to exhibit lower day-to-day volatility in their Net Asset Values (NAVs) compared to duration funds. Duration funds, driven by active portfolio management and sensitivity to interest rate changes, are inherently more volatile.
However, accrual funds carry their own set of risks. Investments in lower-rated debt securities can lead to sudden NAV declines in case of issuer defaults. Recent instances of credit rating downgrades and defaults affecting debt funds linked to entities like IL&FS, DHFL, and the Reliance ADAG Group underscore these risks.
Why You Should Consider Accrual Funds
Investing in debt funds offering high returns often involves balancing risks associated with duration and credit. Accrual funds, traditionally favored by low- to medium-risk investors for their perceived stability, have demonstrated that low day-to-day volatility does not eliminate underlying risks. Recent events highlight how defaults and downgrades can swiftly impact NAVs, causing unexpected losses.
Rather than frequently switching between accrual and duration strategies, prudent investors align their choice with their financial objectives. Accrual funds are suitable for investors seeking regular income, provided they select funds with moderate returns and portfolios consisting of high-quality, AAA-rated securities.
Navigating the complexities of debt mutual funds requires a thorough understanding of the risks and benefits inherent in each strategy. Whether opting for stability with accrual funds or pursuing potential gains through duration strategies, informed decision-making is essential for achieving investment goals.
