LIC Bond Fund: Invest

Recommendation: Invest

B. Venkatesh

LIC Bond fund appears a good medium-term investment for those wanting steady returns from a basket of fixed-income securities. The Growth option returned 13.7 per cent since this January. The returns compare well with alternate retail fixed-income investments.

Suitability: The fund is suitable for those looking for low credit-risk medium-term investment in a basket of fixed-income securities. Investors may opt for the Growth option due to better post-tax returns; the Dividend option suffers 22 per cent on dividends paid.

Portfolio: The fund has exposures in both corporate and government bonds. As of July, 2000, the fund had a 71 per cent exposure to corporate bonds and just 13 per cent in government bonds. The rest was held in cash and cash equivalents. The average portfolio duration was 3 years.

Investors need to consider the following factors before buying into the fund. First, the implication of having a higher exposure to corporate bonds. The positive aspect is that corporate bonds are not as volatile as government bonds.

Take July, 2000 when government bonds were very volatile consequent to the rupee falling sharply against the dollar. The volatility in the 10-year and one-year bond yields were 18 per cent and 39 per cent respectively. In contrast, the volatility in the net asset value (NAV) of the LIC Bond Fund during the same period was just 1.34 per cent. This low volatility can be attributed to the fund's high exposure to corporate bonds. The flip side is the limited capital appreciation on corporate bonds. This means the fund's returns will primarily constitute interest received on the bonds.

Second, consider the securities that constitute the fund's corporate bond portfolio. The fund appears to have sizable investments in public sector bonds and AAA-rated corporate bonds. While such a portfolio ensures that the fund's credit risk is low, it also means that the credit spread over government bonds is not more than one percentage point; credit spread refers to the higher yield that corporate bonds provide over the government bonds to compensate for the credit risk.

The third factor is the portfolio duration of three years. This refers to the number of years within which the fund can get back its investments in bonds. The portfolio duration has to be viewed in the light of the interest rate expectations in the market.

At present, the market appears uncertain on interest rate movements. This is because of the Reserve Bank of India's (RBI) conflicting objective of lowering interest rates as well as defending the rupee.

The confused interest-rate movements has prompted most funds to hold short-term bonds, and LIC Bond Fund is no exception. It needs to be mentioned here that the Fund's present portfolio runs the risk of sharp fall in value should interest rates fall in the medium-term.

On the whole, given the portfolio composition and the uncertainty on the interest-rate front, investors with a medium-term horizon wanting steady returns may buy the fund.

Background: LIC Bond Fund was launched in March 1999. The fund has two options -- Growth and Dividend. Dividends paid since launch aggregate 11.5 per cent. The minimum amount needed to buy units in the fund is Rs. 5,000. The fund does not charge an entry load but levies an exit load of 0.5 per cent if the units are redeemed within 6 months of investment. The fund size as of July, 2000 was Rs. 241.79 crores. The NAV for the Growth option as on August 16 was Rs. 11.74 and for the Dividend option was Rs. 10.39.