When we hear the term passive fund management, we instantly recall passively-managed equity funds that follow an index. Well, have you heard about passively-managed debt funds? Not really, isn’t it? Most mutual fund investors are not familiar with these funds.

Usually, passively-managed funds follow an index. Same is the case with passively-managed debt funds. However, there is a subtle difference here. In equity, there are existing and widely-followed indices, say, Nifty or Sensex. In debt, there is no widely followed index. Hence, when an AMC decides to float a passive debt fund, the strategy is decided and a customized index is constructed by the provider. For example, NSE or Crisil. That is, the index is unique and no other MF Scheme would follow that. The category of funds that follow these customized indices are Target Maturity Funds (TMFs). TMFs have a defined maturity date, a defined portfolio allocation comprising State Development Loans, AAA-rated PSU bonds and Government Securities. As per the fund mandate, the index provider – NSE or Crisil – would run the index and the AMC will replicate that. When the fund matures, the index ceases to exist.

It is not a given that passive fund management has to necessarily follow an index. The term passive means there is no active involvement of the fund manager in terms of decision making on what to buy or sell or in terms of active portfolio management. If the fund is left on its own, then it is effectively run passively. The MF fund category that answers this description is Fixed Maturity Plans (FMPs). Though as per regulation the fund manager of an FMP can make changes in the portfolio, these are usually run passively. The initial portfolio is constructed, and as per rule the maturity of the instruments in the portfolio are within the maturity of the product. Then the portfolio is left as it is..

There is another method in which debt funds are run passively. There are certain open-ended debt funds, where the strategy followed by the AMC is that of maturity roll-down. Like in TMFs and FMPs, with every passing day, the remaining portfolio maturity of the fund comes down. There is no active fund management from the fund manager in terms of portfolio maturity modulation. There is no index that is replicated, but like in FMPs, the portfolio is left as it is. However, it is quasi-passive because sometimes, the portfolio composition may change. When the fund gets fresh subscriptions, the money is invested in the market and the fund manager buys securities with maturity around the portfolio maturity of the fund, to honour the maturity roll-down. In the process, the fund manager may buy securities already in the portfolio, or other securities (not in the portfolio) or securities in different proportion.

How do passively-managed debt funds help you? There is high visibility of returns. Usually the portfolio yield-to-maturity (YTM) or net-of-expenses YTM is taken as the proxy for expected returns from debt funds. Given that the market is dynamic and the portfolio of usual open-ended funds are subject to change, YTM is not a commitment on returns. In passively managed debt funds also, while the YTM is not a guarantee or commitment from the AMC on returns, it gives visibility. As long as you remain invested in the fund till maturity, your return will be somewhere around the net YTM you are entering at, may be little bit here or there. In the usual open-ended debt funds, as long as you remain invested for an adequate horizon, you get decent returns by virtue of accruals. In those funds also, the net YTM may give you an informal indication of expected returns. The differential is, in passively managed debt funds, it gives a better indication.

Source: https://economictimes.indiatimes.com/mf/analysis/how-do-passively-managed-debt-funds-help-you/articleshow/93629703.cms?from=mdr