Short Note: Accrual Funds

Accrual funds may be described as debt mutual funds which aim at earning an income in the form of interest basically from the coupon that is offered for the securities held in the portfolio. They are in contrast to the duration funds which aim at earning a significant amount of returns from the capital appreciation resulting from decline in interest rates. Accrual funds also have a small portion of their return from capital gains, but not a very significant one.

Working of Accrual Funds

These follow a buy and hold strategy, these instruments are held till their maturity. But duration funds can be managed as per the interest views of the fund manager. There are primarily two categories of accrual funds. These are

  • Credit opportunity funds-This bond works on the basis of the mismatch in the rating of the bond and the fundamentals of the company. So, the credit rating of these bonds may be upgraded due to the improving fundamentals of the company. It involves greater risk than corporate bond funds as these invest in lower rated papers.
  • Corporate bond fund-These are lower risk involving accrual funds. They do not look for mismatches and invest in only the higher quality papers. They do not take the extra credit risks.

These funds are mainly recommended by the financial planners in the end of the rate cut cycle or when a rate cut is expected. This is because these funds are less volatile and capital depreciation with respect to these funds is much lower in an environment of rising interest rate. But nonetheless, during steep and fast rise in interest rates these also start becoming more volatile.

Accrual funds provide the best route for investments for the investors who do not wish to take up high risks that is, seek less volatility and want stable returns. These also come with some tax exemptions-instead of general taxation of securities at the rate of 30% these are taxed at 20%. There is also indexation benefit on the capital gains on these funds.