strategy operations

Debt funds invest in fixed income instruments, such as bonds, commercial papers, certificates of deposit and treasury bills. These instruments are safer than equities, but are not completely free from risks. The main factors that impact the value of debt instruments are interest rates, exchange rates, inflation and policies of the central bank. Apart from these, a weakening of credit rating of the issuer is also a source of risk for non-government debt papers. Let us look at some of the strategies that debt fund managers adopt.

Buy and hold: It is also known as the passive debt management strategy, wherein the fund manager invests in high-yielding debt securities and aims at holding them till maturity. He en cashes on the regular coupon payments and the returns thus generated are considered sufficient to reward the investors. However, the strategy holds good as long as the general interest level remains stable. Any increase in interest rates or yields results in a capital loss to the portfolio. This, in turn, negatively affects the NAV of the fund.

Duration management: It is an active debt management strategy and involves altering the average duration of bonds. Duration is a measure of the sensitivity of a debt instrument, say, bonds, to changes in interest rates. Generally, the longer the duration, the higher the sensitivity, and vice versa.
The fund manager alters the average duration of bonds according to his expectations of the future direction of interest rates. If the rate is expected to fall, the fund manager buys bonds with longer duration and sells those with shorter duration. This process continues until the fund's average duration rises above the market average duration. This strategy is akin to the timing strategy that is followed in equity markets.
Credit selection: This strategy involves an investment in debt instruments in anticipation of the changes in their credit rating. Any increase (or likely rise) in the credit rating of a debt