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B. Venkatesh

SUNDARAM Income Plus (Growth) returned 11.5 per cent since its launch last July. The fund is suitable for investors wanting to construct a diversified bond portfolio.

Investors need to consider the following factors before buying the units: The fund primarily invests in corporate bonds with credit rating below AAA. The positive side is that scope for capital appreciation in such bonds is high.

Corporate bond prices are a function of credit spreads and comparable maturity government bond prices. A 5-year AA-rated corporate bond, for instance, will be priced based on the price of the 5-year government bond and the credit spread of AA-rated bonds; credit spread is the yield differential between a corporate bond and a government bond.

The price of AA-rated corporate bond can, hence, rise if the price of the government bond increases and/or credit spreads shrink. Now, credit spreads typically shrink when credit risk declines. And that normally happens when companies issuing such bonds show improvement in financial performance. That is why scope for capital appreciation is higher for AA-rated bonds than AAA-rated bonds.

Of course, the flip side is that the losses could also be higher. In fact, the credit spread for 3-year AA-rated bonds (to compare against the fund's average portfolio maturity of 3.4 years) has declined from 1.25 per cent to 1.15 per cent since this April. Scope for further tightening of credit spreads exists, which provides some upside to AA-rated corporate bonds.

Further, the fund's strategy to invest in corporate bonds provides good portfolio diversification benefits to investors. Typically, an optimal bond strategy has been to invest in short-term corporate bonds and long-term government bonds. The reason is that corporate bonds provide higher risk-adjusted returns than government bonds in the short-term maturity bucket.

Hence, combining Sundaram Income Plus with a fund that invests primarily in long-term government bond may be good strategy for retail investors.

Of course, unit-holders' returns will depend largely on the bond selection. The reason is that the fund will lose sharply if the portfolio manager buys a corporate bond that is subsequently downgraded. Besides, the likelihood of payment default by a company floating AA-rated bond is higher than that of a company issuing AAA-rated bond.

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