LIC Bond Growth: Invest

Recommendation: Invest

B. Venkatesh

LIC Bond Fund (Growth) returned just over 10 per cent in the last one year. One may consider investing in the fund as the returns compare well with the other retail fixed-income instruments even without adjusting for liquidity.

Suitability: The fund is suitable for those willing to take a somewhat higher credit risk. The higher risk stems from the fund's 24 per cent exposure in below-AAA rated instruments and low holdings in Government bonds. The positive aspect is that the lower exposure to Government bonds reduces fluctuations in net asset value (NAV).

Portfolio: As of December 31, 2000, the fund had nearly seven per cent exposure in Government bonds, 75 per cent in corporate bonds and the rest in cash and near-cash instruments. The average portfolio maturity was 3.4 years.

Investors may want to consider the following factors before buying into the fund:

First, the exposure to below-AAA rated corporate bonds. The positive aspect is that such bonds offer higher coupon rates, boosting the fund's NAV due to higher interest income. Moreover, if the Reserve Bank of India were to bring down interest rates, these bonds might rise sharply due to demand for higher coupons. On the flip side, the likelihood of payment defaults by companies issuing such below-AAA rated bonds could be high. More so considering that the economy is not expected to perform well in the coming fiscal.

Second, consider the fund's strategy of trading Government bonds, holding corporate bonds as the core portfolio. This strategy cuts both ways. Given the sharp fluctuations in Government bond prices, the fund could make large trading gains when Government bonds are on the uptick. An increase in the price of crude or a sharp fall in the rupee, on the other hand, could send Government bond prices into a downdraft and pull down the NAV. The fund may not, however, take a huge knock in its NAV if it trades in short-term bonds as moving into cash is easier in the event of a fall in prices.

Third, the fund's portfolio maturity at 3.4 years is longer than most other debt funds. The implication? If the interest rates were to remain stable, demand may slowly shift from short-term bonds to medium and long-term bonds. And that augurs well for unit-holders as the fund holds relatively long-dated securities.

Another factor is that the fund could enjoy some convexity gains that typically increase as bond maturity lengthens; convexity refers to the feature that makes bonds rise sharply when interest rate falls and to fall gradually when rate rises.

In the light of the above factors, one may buy units in the fund for long-term gains.

Background: LIC Bond Fund offers growth and dividend options. The fund does not charge an entry load but levies an exit load of 0.5 per cent if the units are redeemed within six months of investment. The minimum amount needed to buy units in the fund is Rs 5,000. The current NAV of the growth option is Rs 12.29.