Sundaram Bond Saver -- A good option for steady returns

Recommendation: Invest

B. Venkatesh

GIVEN the track record of the fund and its portfolio composition, the Sundaram Bond Saver is a good investment option in the fixed income arena.

Suitability: The dividend option is suitable for investors looking for steady income flows with medium risk. The cumulative option may, however, be suitable for investors in the lower tax brackets.

Fund performance: The dividend payouts since inception aggregate 27 per cent, an annualised return of over 11 per cent. Add another 2 per cent return for growth in the current net asset value and the annualised return comes to about 13.4 per cent.

Some may be quick to point out that investors in the dividend option may run a re-investment risk; the risk that the money received as dividends may have to be re-invested at a lower rate. But this is a risk that is applicable to all such investment options involving regular payouts.

What about the appreciation option? This option has returned about 15.5 per cent on an annualised basis, nearly 2 percentage points higher than the dividend option.

Investors who are comfortable with receiving periodic returns by way of cash can choose the dividend option rather than the appreciation option. This may also ensure that the downside is limited in the event of a fall in bond prices.

The government bond market has exhibited a high degree of volatility in recent times. Under such circumstances, the dividend option holders would have received some portion of the income and capital appreciation as dividend payouts. In a volatile market there may be some merit in following the adage, ``a bird in the hand is worth two in the bush.''

Portfolio analysis: The Bond Saver has exposures in government bonds, AAA and AA rated corporate bonds and in unrated corporate instruments. There has been a clear bias towards increasing exposures to government bonds in the last few months. From less than 30 per cent this January, government bonds now constitute nearly 50 per cent of the portfolio.

The strategy seems to be based on shrinking credit spreads. Credit spreads refers to the yield differential between government bonds and corporate bonds of the same maturity; the higher yield for corporate bonds being the compensation for the higher risk associated with such investments.

In the last few months, credit spreads have been down to just 100 basis points. Perhaps, the fund manager is of a view that the yield differential is not commensurate with the higher risk.

What is the consequence of taking higher exposures to government bonds? The upshot is that the fund is now exposed to a higher market risk. The reason? Government bonds have been wobbly in recent times due to confused signals on future interest rates. Take the five-year bond. It traded at yields ranging from 9.78-9.83 per cent in May. Such volatility subjects the bond portfolio to risk.

Having said that, another point needs to be mentioned here. Unlike government bonds corporate bonds run a credit risk as well; the risk of the company defaulting on its interest and principal payments. Moreover, corporate bonds lack liquidity. Against this backdrop, the higher exposure to government bonds, market risk notwithstanding, may be a favourable strategy from the unit-holders point of view.

Fund facts: The Sundaram Bond Saver is a debt fund managed by Sundaram Mutual fund. The fund's objective is to earn income from investments in fixed-income securities. The fund has two options, the appreciation option and the dividend option; the former re-invests the dividend instead of paying it to the unit-holders. The fund charges an exit load of 0.5 per cent if unit-holders redeem before 6 months of investing.