New year; same old problems.

Debt mutual funds continue to be hit by rating downgrades, in turn damaging investors’ portfolio returns as well as confidence in debt market. In the past, debt mutual funds had exposure to toxic debt papers of IL&FS, DHFL, ADAG group companies, and ZEE group companies. Consequently, fund houses had to write-off their investments and their NAVs took a huge knock.

On December 30, 2019, CARE Ratings downgraded various debt categories of Yes Bank and assigned a negative outlook. The agency downgraded Infrastructure Bonds worth Rs 5,000 crore, Lower Tier II Bonds worth 2,530 crore, and Tier II Bonds (Basel III) worth Rs 8,900 crore to Care A from Care A+.

Upper Tier II Bonds worth 904 crore and Perpetual Bonds (Basel II) worth Rs 82 crore have been revised to Care A- from Care A.

The high-risk high-yield Basel III compliant Additional Tier I Bonds worth Rs 3,600 have been downgraded from Care BBB+ to Care BBB.

Reason for rating downgrade

Private lender Yes Bank has been grappling with high NPAs and corporate governance issues; it is in desperate need of raising capital to comply with RBI norms.

Table 1 : Financials of Yes Bank show deterioration in asset quality and profitability

Particulars	FY17 (A)	FY18 (A)	FY19 (A)
Total Income	20,581	25,491	34,215
PAT	3,330	4,225	1,720
Total Assets*	2,14,457	3,11,574	3,78,293
Gross NPA(%)	1.52	1.28	3.22
ROTA(%)	1.76	1.61	0.50

Figures are in Rs crore
A: Audited *Adjusted for Deferred Tax Assets
(Source: Care Ratings)

At the end of November 2019, Yes Bank instrument ratings were on `Credit Watch with Developing Implications’ when Yes Bank unveiled its plan to raise USD $ 2 billion in capital from SGPG Holding and Citax Holdings. The capital infusion is expected to enhance the capital buffers to absorb the credit losses and support business growth. However, there has been a delay in fund raising as per the earlier estimated timeline.

Care Ratings had earlier downgraded ratings of various Yes Bank instruments on November 13, 2019 due to the deterioration in the asset quality parameters.

[Read: Does Your Debt Mutual Fund Scheme Have Exposure To Debt Papers Of Yes Bank And Altico Capital?]

As per Care Ratings, The outlook for the ratings is ‘Negative’ considering the uncertainty related to raising equity, which is critical for the bank to maintain adequate capital buffers over the minimum regulatory requirement as well as fund future growth of the bank. The outlook also considers slippages to continue in H2FY20 and muted recoveries from non-performing assets.

Mutual funds with exposure to Yes Bank debt

As on November 30, 2019, mutual funds have an exposure of Rs 2,932 crore to debt instruments of Yes Bank. Nippon India Life Asset Management has the highest exposure of Rs 1,847 crore to Yes Bank debt instruments through its various schemes. The schemes with highest exposure include Nippon India Equity Hybrid Fund (Rs 653 crore), Nippon India Credit Risk Fund (Rs 552 crore), and Nippon India Strategic Debt Fund (Rs 446 crore). Franklin Templeton Asset Management (India) and UTI Asset Management are the other AMCS with high exposure.

Table 2 : AMCs with highest exposure to Yes Bank debt in terms of market value

AMC	Market Value (Cr.)
Nippon India Life Asset Management Limited	1,847.64
Franklin Templeton Asset Management (India) Private Limited	481.18
UTI Asset Management Company Private Limited	383.52
Kotak Mahindra Asset Management Company Limited	96.17
Baroda Asset Management India Limited	54.98
PGIM India Asset Management Private Limited	33.16

Data as on November 30, 2019
(Source: ACE MF)

In terms of percentage of assets, Nippon India Life Asset Management’s exposure to Yes Bank debt as percentage of its debt holding is around 2.2%, which accounts for 0.9% of its total assets. PGIM India Asset Management, Baroda Asset Management India, and Franklin Templeton Asset Management (India), among others have high exposure as percentage of assets. Baroda Treasury Advantage Fund (23.49%), Nippon India Strategic Debt Fund (17.43%), and IDBI Credit Risk Fund (12.22%) have the highest exposure as percentage of asset.

Table 3 : AMCs with highest exposure to Yes Bank debt in terms of % of assets

AMC	Holding % (Assetwise)	Holding % (OverAll)
Nippon India Life Asset Management Limited	2.18	0.88
PGIM India Asset Management Private Limited	1.34	0.82
Baroda Asset Management India Limited	0.75	0.48
Franklin Templeton Asset Management (India) Private Limited	0.73	0.37
UTI Asset Management Company Private Limited	0.55	0.24
IDBI Asset Management Ltd.	0.38	0.15

Data as on November 30, 2019
(Source: ACE MF)

Shareholders are not convinced about the capital infusion deal as the Canadian investor who has promised to infuse capital in Yes Bank has a history of failed businesses, bankruptcies, and litigation. The investor may thus fail to clear RBI’s `fit and proper’ criteria for investment in banks, causing the bank bigger troubles to raise capital. With such prevailing concerns, Yes Bank instruments may see further downgrades in the near term putting them at higher risk of default.

Mutual funds with exposure to such instruments will then have no choice but to write off investments or create side pockets. If the fund house is confident about recovering money from the debtor, creation of side pocket might help.

Side pocketing is an accounting method of calculating two Net Asset Values (NAVs) of a scheme by demarcating good assets from troubled assets. Redemptions and purchases are allowed only through the bucket of good assets. As and when the issues of troubled assets are resolved, investors can liquidate their holdings in that bucket as well.

However, it is not always possible for mutual funds to write off the losses made by their schemes. If the fund decides to write off its holdings, it will reflect in the NAV of those schemes. This is because mutual funds are essentially pass-through vehicles, wherein NAV ought to reflect the correct value of assets held at any time.

What should debt mutual fund investors do?

If you already have exposure to debt mutual fund schemes with exposure to debt instruments of Yes Bank, you could possibly do away with the ones that would prove perilous to your wealth after conducting a systematic portfolio review.

It is important for you, as an investor, to approach debt mutual funds with caution and your eyes wide open. Do not assume debt mutual funds to be risk-free; they are not! All investments are subject to market risk.

Before investing in debt funds, understand the credit risk involved. If one does not pay attention to the portfolio characteristic of a debt mutual fund scheme, it can result in making the wrong investment choices, thus leading to wealth erosion.

That being said, credit risks can randomly knock on doors and avoiding them is almost impossible — even for a seasoned fund manager or an investment advisor. However, a process-driven approach, less dependence on concentrated exposures (for generating higher returns), and focus on portfolio characteristics can help reduce the risk involved when you choose a debt mutual fund scheme.

This article first appeared on PersonalFN here