Market regulator SEBI has intensified its pace to fix debt funds. In my recent article, I had talked about how SEBI plans to ensure that liquidity of debt funds is not compromised.
Mandatory liquidity buffer, gating of redemptions, stress testing of all debt schemes, and revisiting side-pocket norms are some of the considerations that it will be looking at. Further, to ensure better transparency and disclosure pertaining to debt schemes, SEBI has introduced two new norms based on the recommendation of Mutual Fund Advisory Committee (MFAC). These norms will come into force from October 1.
One, mutual funds will be mandated to undertake at least 10% of their total secondary market trades by value (excluding inter-scheme transfer trades) in corporate bonds/commercial papers through one-to-many mode on the Request for Quote (RFQ) platform of stock exchanges. Notably, mutual funds are one of the major active players in the corporate bond segment.
RFQ is a platform for the execution and settlement of trades in debt securities and National Stock Exchange (NSE) manages it. The platform enables interaction amongst the market participants who wish to negotiate transactions amongst themselves.
Security-related details such as yield, value, settlement date, and other parameters like identity disclosure (anonymous/disclosed), private/public, fixed/negotiable, quantity condition, etc. are provided on the trading screen. The initiator of trade has the flexibility to choose the eligible participants for specific securities who will be allowed to respond/negotiate to the quotes.
The percentage specified will be the average of secondary trades by value in the immediate preceding three months on a rolling basis. For example, for the month of October, mutual funds will need to undertake at least 10% (by value) of their average secondary market trades done between July and September for corporate bonds through the RFQ platform.
SEBI further stated that, all transactions in corporate bonds and commercial papers wherein mutual funds are on both sides of the trade shall be executed through RFQ platform of stock exchanges in one-to-one mode.
Any transaction entered by mutual fund in corporate bonds in one-to-many mode and gets executed with another mutual fund shall also be counted for the aforesaid 10% requirement.
At present, corporate bond transactions in secondary market takes place over the counter via brokers. However, since these deals take place on a private placement basis, it can lead to opacity in pricing. Trading through RFQ platforms is expected to bring in better price discovery and transparency for corporate bonds as well as increase liquidity on the exchange platforms.
In another move, all debt schemes will have to disclose portfolio on fortnightly basis within five days of every fortnight. Additionally, the portfolio disclosure should mention yields of the underlying instruments, which would give investors a better sense of the risk factor.
Though funds currently disclose portfolio on a monthly basis, it may not reveal the complete picture of the portfolio quality, especially in case of shorter duration funds which invest in securities with short-term maturity.
For example, the six shuttered debt schemes of Franklin Templeton faced heightened redemption pressure and increased borrowings in the days leading up to winding-up. If there was norm for mandatory fortnightly disclosure at that time, it would have made the investors/financial advisers aware about the pressure the fund had been dealing with and they could have taken necessary action.
The move could also prevent funds from taking higher credit risk through short-term transactions in a bid to earn high yield. Thus, it would help investors to keep an eye on any early warning signs and save themselves from any potential risk the fund may be exposing them to.
SEBI’s transparency norm is a step in the right direction. However, in the current scenario where the spate of downgrades and defaults are expected to rise, it is important to be extra-cautious while investing in debt funds. Ideally, stay away from funds with high exposure to private issuers.
To select a scheme, essentially assess your risk appetite and investment time horizon, plus factors such as:
- The portfolio characteristics of the debt schemes
- The average maturity profile
- The corpus & expense ratio of the scheme
- The rolling returns
- The risk ratios
- The interest rate cycle
- The investment processes & systems at the fund house
In the current scenario, where interest rates seem almost bottomed out, you would do better going with low duration funds such as pure Liquid Fund and/or an Overnight Fund that does not have high exposure to private issuers.
This article first appeared on PersonalFN here