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While all eyes are on the stock indices scaling new lifetime highs, the bond market also offers attractive opportunities. Yields on commercial paper and bonds from highly rated corporates are ruling at near 8 per cent levels, with credit offtake picking up. Conservative Hybrid Funds make for a good investment for investors who are bullish about bonds but wary of equity risks. These funds invest over 70 per cent of their portfolio in bonds, with a 25-30 per cent equity component to provide a kicker to returns.
While funds with longer track records in this category have managed a five-year CAGR of 11-14 per cent, the three-year-old Parag Parikh Conservative Hybrid Fund stands out for its low-risk approach to managing both the debt and equity components of its portfolio.
Lower equity allocation
The four most popular funds in the conservative hybrid category maintain equity allocations ranging between 23 and 25 per cent of their assets. In contrast, Parag Parikh Conservative Hybrid Fund (PPCHF) has retained less than 15 per cent direct equity exposure, parking an additional allocation in equity arbitrage positions. At the end of December, the fund had 12.8 per cent in direct stock holdings and another 2.7 per cent in arbitrage. As latter is a debt-like exposure, the fund carries much lower equity risks than its peers.
Dividend tilt in equity
The equity holdings of PPCHF also have a large-cap tilt, with 77 per cent of the equity holdings in large-cap stocks. But more importantly, the fund’s stock selection focuses mainly on identifying stocks with high dividend potential. This is evident from Bajaj Auto, Petronet LNG, PowerGrid, Coal India, ITC, Swaraj Engines and Indraprastha Gas, making up the entire equity holdings at the end of December 2023. The fund has consistently picked high dividend yield stocks while avoiding the value traps that are quite common in dividend investing in India. The fund seems to rarely churn its equity holdings. The only change has been IRFC exiting the portfolio to be replaced by Swaraj Engines in the last couple of months.
This approach may lead to more moderate returns from PPCHF’s equity portfolio than those of peers (who own more growth-oriented portfolios) in a trending bull market. But it is also likely to impart greater stability to the returns and contain the downside well in the event of a sharp market fall. The probability of such a correction has increased after the breathless rally in equities in the past year. The portfolio PE seems to be at a significant discount to the market, at about 13 times.
Sticking to sovereign debt
If a penchant for dividend-yielding stocks marks out the fund’s equity strategy, its debt strategy is equally conservative. Popular funds in this category use a mix of sovereign and corporate bond exposures to bump up portfolio yield. At the end of December, the top four funds had corporate bond exposures ranging from 16-48 per cent in their debt portfolios, with some funds featuring below AAA bonds as well.
However, PPCHF has stayed almost exclusively with sovereign debt, with significant exposure to State Development Loans (SDLs) for its debt component. About 68 per cent of total assets at the end of December were parked in SDLs, with 4 per cent holding certificates of deposit and commercial paper making up the rest of the debt exposure. While SDLs offer spreads of 40-50 basis points over Central government debt, these instruments are close to Central government debt in safety because of repayments being managed by the Reserve Bank of India through an escrow mechanism. The sovereign tilt results in PPCHF’s debt portfolio yield to maturity (YTM) at 7.6 per cent at the end of December 2023, being lower than the popular funds which featured YTMs of 7.7 to 8.3 per cent.
While the fund takes on minimal credit risk, it does carry some duration risk owing to SDLs usually featuring longer maturities. Its average portfolio maturity was about 4.6 years by the end of December. But top funds in the category also carry significant duration risks at this time, given the expectation of a decline in rates, with average portfolio maturity ranging from 5 to 10 years. PPCHF also features a 7.7 per cent exposure to the Embassy Office Park, Brookfield and Mindspace Real Estate Investment Trusts to supplement its income.
Suitability
The above break-down of the fund’s strategy suggests that PPCHF’s returns may undershoot those of peers in bull markets for both equities and bonds. But the ultra-conservative strategy makes the fund a suitable option for three categories of investors: first-time mutual fund investors, those seeking regular income, and those seeking a safe parking ground for profits booked in equities.
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