What are Banking and PSU Funds ?

Banking and PSU Funds are fixed-income funds which invest in debt and money market instruments issued by Banks, Public Sector Undertaking (PSU) and Public Financial Institutions (PFI). As per a mandate from the Securities and Exchange Board of India(SEBI), Banking and PSU Funds must invest at least 80% of their assets in instruments issued by such institutions. Debt and money market instruments issued by Banks and PSUs usually are of superior credit quality and more liquid compared to instruments of other private sector issuers. There are 19 Banking and PSU debt schemes with around Rs 89,962 crore of assets under management (AUM) as on 31^st May 2020. ¹

The investment strategy of Banking and PSU Funds:

Debt Fund Categories. 1-year return.         3-year return.       5-year return. 

Banking and PSU Funds      10.6%                   8.2%                     8.4%

Dynamic Bond Funds.         5.0%.                     8.6%                     5.9%

Gilt Funds.                           11.9%                     7.8%                     9.3%

Corporate Bond Funds.     10.8%.                    7.3%                    7.9%

Credit Risk Funds             -2.8%                        0.9%                   4.0%

Short Duration Funds.       7.6%                        5.6%                   6.8%

Low Duration Funds.        3.8%                         3.9%                   5.4%

Money Market Funds.      7.4%                         7.2%                   7.3%

The four aspects of investment strategy for these schemes include:

• Maintain high credit quality: These schemes mostly aim to invest in the highest quality papers.
• Short to moderate duration profiles: These schemes have moderate interest rate risk. Most of the Banking and PSU fund portfolios have 2–5-year modified duration. ²
• Hold to maturity: These schemes usually hold to maturity the debt and money market instruments generating income from the interest paid by these securities and receive face value (principal) on maturity.
• Moderately active duration management: The fund managers take active duration calls based on their interest rate outlook. In the one last year, the funds were able to give double-digit returns due to falling interest rates.³

Why should you invest in Banking and PSU Funds?

Banking and PSU Funds usually have a moderate interest rate risk. While the funds benefit from lower interest rates, the downside risk in a rising interest rate environment is limited. These schemes typically have attractive yields to maturity despite their despite having a good credit quality.

First, one of the most important factors which have enabled Banking and PSU Funds in delivering good returns is ‘superior credit quality’.⁴ The instruments in which these schemes invest in accordance with SEBI’s mandate are inherent of high credit quality.PSUs enjoy quasi-sovereign status because they have Government backing. Banks (both public sector and private sector) enjoy high credit rating because they are regulated entities and are usually well-capitalized.

Secondly, Banking and PSU funds have outperformed most debt fund categories. The average annualized returns of Banking and PSU Funds category versus several other debt fund categories across the maturity profile spectrum. Banking and PSU Funds clearly outperformed most debt fund categories.(see table below)

Debt Fund Select Category Trailing Returns (periods ending 15^th June 2020)

Source: Advisorkhoj research, as on 15^th June 2020.

Past performance may or may not sustain in future. The data/performance provided above pertains to the category of schemes and does not in any manner constitute performance of any individual scheme of the Fund.

Market Scenario

Given the current economic environment, with growth slowing down and RBI committed to accommodative monetary policy, debt mutual funds are likely to outperform traditional fixed income products. At the same time, the credit environment in India has been worsening for some time and with businesses grinding to a halt due to the lockdown, debt servicing ability of many issuers may become questionable.Banking and PSU Funds are well suited in the current conditions as they have attractive yields, moderate interest rate risk and most importantly, high credit quality.

These funds are suitable for investors with moderate risk appetite. Investors will enjoy the benefit of long-term capital gains tax if they stayed invested for more than 3 years. Investors should consult with their financial advisor if Banking and PSU funds are suitable for their investment needs.

Mr. Vaibhav Shah—Head, Products, Mirae Asset Investment Managers India Pvt Ltd.