These are tough times for debt mutual fund investors. On the one hand, there has been a recent instance of Franklin Templeton Mutual fund winding up six of its debt schemes that had a very high-risk exposure to low rated and toxic debt papers (and cited COVID-19 dislocations to put a stop to losses); and on the other, some debt schemes are discouraging fresh investments.

Recently, Aditya Birla Sun Life Mutual Fund temporarily suspended fresh subscriptions with effect from May 22, 2020, in two debt scheme: Aditya Birla Sun Life Medium Term Fund and Aditya Birla Sun Life Credit Risk Fund till further notice; a move the fund house says is in the interest of investors.

“We have stopped taking additional money in our credit-oriented funds – Medium Term Plan and Credit Risk Fund. We believe that there are substantial gains in our funds which would be realized by the existing investors over the next few months. Since we do not wish to dilute this for existing investors by taking more money in these funds, we have stopped fresh subscriptions in these funds. This is done in the interest of investors,” — Statement issued by Aditya Birla Sun Life Mutual Fund

The fund house clarified that SIP/CSIP/STP instalments already registered before the effective date (i.e. May 22, 2020) will continue to be processed under the respective plans/options of the scheme. Fresh SIP/STP mandates will not be registered.

This decision has baffled many investors and made them wonder if their investments in the aforementioned two debt schemes are safe – particularly now as the credit risk has amplified amidst the COVID-19 crisis.

To avoid this decision leading to a miscommunication in any form, A Balasubramanian, MD & CEO of Aditya Birla Sun life Mutual Fund clarified the reasons for stopping fresh subscriptions. “We believe there are substantial gains in our funds which would be realized by the existing investors over the next few months. Since we do not wish to dilute this for existing investors by taking more money in these funds, we have stopped fresh subscriptions in these funds,” he said.

The Assets Under Management (AUM) of Aditya Birla Sun Life Medium Term Fund and Aditya Birla Sun Life Credit Risk Fund was Rs 7,038 crore and 6,367 crore, respectively in June 2019. And as per the latest portfolios revealed on April 30, 2020, Aditya Birla Sun Life Medium Term Fund had an AUM of Rs 2,400 crore, while Aditya Birla Sun Life Credit Risk Fund managed Rs 2,576 crore. This reveals the level of redemption and stress these funds have faced in the past.

The report card: Nothing to vie for

Scheme Name 1-year Return Holding (% of Total Assets)
AAA/A1 AA A & below G -sec Cash, equivalents and others
Aditya Birla SL Credit Risk Fund 2.40% 28.16 50.37 18.14 Nil 3.33
Aditya Birla SL Medium Term Plan -7.44% 37.48 28.5 15.11 14.46 4.45

Data as on May 22, 2020
Note: Direct Plan and Growth Option considered
Source: ACE MF, PersonalFN Research

The 1-year return generated by Aditya Birla Sun Life Medium Term Fund is discouraging (eroded investors’ wealth) and that of Aditya Birla Sun Life Credit Risk Fund isn’t attractive either. The hunt for yield (with low-rated papers) has not rewarded investors well; on the contrary, exposed investors to high risk.

A point to note is, except ‘AAA’ rated papers and government securities, the other segments of the Indian debt market are grappling with liquidity issues because the credit risk has got amplified. Also, in the past, both these schemes had exposure to the troubled debt of IL&FS group and Essel group. Side-pocketing was followed, but eventually, some of the debt papers had to be written down and that led to investors to suffer losses.

The fund house has been expecting some recovery in the marked-down assets – but has not clearly pinpointed which ones are they and the potential impact on the respective scheme’s NAV. Both these funds have very high exposure to energy sector companies and Non-Banking Financial Companies (NBFCs).

Recently, while announcing the Atmanirbhar Bharat stimulus package, the finance minister allocated liquidity support worth Rs 90,000 crore to discoms. Similarly, a special liquidity scheme of Rs 30,000 crore and a partial guarantee scheme of Rs 45,000 crore was announced to improve the liquidity situation of NBFCs. Besides, the Reserve Bank of India (RBI) also offered them liquidity support by releasing Rs 50,000 crore through Targeted Lending Term Repo Operations (TLTRO 2.0). Furthermore, the central bank slashed Repo rates from 4.4% to 4.0% on May 22, 2020; making the cost of loans cheaper. All these factors appear to be a silver lining that might improve the performance of the underlying portfolios of these debt mutual fund schemes.

Having said that, the aforementioned debt schemes of Aditya Birla Sun Life Mutual Fund have failed to reward investors for the risk taken (and so have similar debt mutual fund scheme from a few other fund houses). They are just hoping to recover losses reported earlier.

What should investors in debt mutual funds scheme do?

Time and again, at PersonalFN we have highlighted the risk element involved in debt mutual fund investing. But, ever since the Franklin Templeton fiasco happened, we have become ultra-conservative and sticking our neck out to tell investors: please avoid ‘debt mutual funds’.

Keep in mind that when the underlying debt security held by a debt mutual fund scheme is downgraded or its issuer stops servicing the debt (or defers payments), the Net Asset Value (NAV) of a debt scheme takes a knock. If the redemption pressure mounts when a security gets downgraded, it results in further losses as the fund house struggles with liquidity issues to facilitate large-value redemptions and ends up selling high-rated instruments. Similarly, when a paper is upgraded, the debt scheme adds back the earlier markdown, and as a result, the NAV increases. But then, the positive impact on the scheme’s NAV depends on the extent of the upgrade; if it is insignificant, it fails to generate meaningful returns for debt fund investors.

Amidst the COVID-19 pandemic, where a financial crisis is also brewing (due to lockdowns enforced to contain the spread of the deadly pathogen), defaults and downgrades are likely to outpace recoveries and upgrades.

It is possible that debt papers which command ‘AAA’ rating today may be downgraded in time to come causing a credit risk contagion across the Indian mutual fund industry. And if that happens, it could be a discomforting experience for debt fund managers and you, the investors.

The COVID-19 pandemic has caused dislocations in terms of credit risk and liquidity. Please note debt mutual funds are not risk-free or safe. The risk you are exposed to depends on the portfolio characteristics of the debt scheme, i.e. the type of debt papers, the issuers (private or government), the quality (AAA, AA+, AA, A etc.), portfolio concentration, maturity profile, etc. and whether or not a debt mutual fund scheme engages in yield hunting.

Besides, pay attention to the following important factors to evaluate debt funds:

  • The investment processes & systems and risk management measures at the fund house;
  • The average maturity profile;
  • The portfolio characteristics details of the debt scheme;
  • The corpus & expense ratio of the scheme;
  • The rolling returns;
  • The risk ratios; and
  • The interest rate cycle

Therefore, don’t invest in debt funds unless you evaluate the above facets and fully recognise the risk involved.

It’s time to follow a conservative approach. Consider only those debt funds that invest at least 80% of their assets in bonds floated by the Government of India and securities issued by public sector companies. For example, Banking & PSU Debt Funds that hold 85%-90% of its assets in instruments issued by major Banks and PSUs. Likewise, a Dynamic Bond Fund, which invests only in government securities and a few selected PSUs.

At this juncture, the repo stands at 4.0%, and although RBI has maintained an ‘accommodative stance as long as it’s necessary’ to address growth concerns, i.e. at least until the economy recovers from the impact of coronavirus pandemic; there’s a limit to which policy rates can further reduce. It seems the interest rates are already near the bottom. Thus, you would be better off investing in a pure Liquid Funds and/or Overnight Fund that do not have exposure to the private issuers and low rated papers.

Looking at the widespread contagion of credit risk and mismanagement of fund houses, I believe the aforesaid sub-categories of debt funds would be befitting for the safety of principal over returns. It is time to stay away from debt mutual fund schemes, particularly the ones holding toxic debt papers.

Our friends at Quantum Mutual Fund have highlighted the secret behind their debt management strategy, which has helped them provide safety and liquidity to investors when it comes to investing in Quantum funds. Don’t Worry, Quantum Liquid Fund always aims for Safety and Liquidity.

Alternatively, if you prefer to keep your capital safe, opt for bank fixed deposits.

Happy Investing!

This article first appeared on PersonalFN here

Leave a Reply

Your email address will not be published. Required fields are marked *