{"id":251,"date":"2019-05-04T05:44:31","date_gmt":"2019-05-04T05:44:31","guid":{"rendered":"http:\/\/blog.certifiedfinancialguardian.com\/?p=251"},"modified":"2019-05-04T06:16:08","modified_gmt":"2019-05-04T06:16:08","slug":"approach-debt-funds-with-your-eyes-wide-open","status":"publish","type":"post","link":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/2019\/05\/04\/approach-debt-funds-with-your-eyes-wide-open\/","title":{"rendered":"Approach Debt Funds With Your Eyes Wide Open\u2026"},"content":{"rendered":"\n<p>The current mayhem in the debt market has affected almost all\ninstitutional investors. <\/p>\n\n\n\n<p>Post demonetisation, inflows in debt funds and liquid funds\nimproved considerably. In October 2016, income funds and liquid funds collectively had an\nAUM of Rs 10.3 lakh crore which swelled to Rs 11.7 lakh crore within a year.\nHeavy inflows in debt funds and relatively benign interest rate regime perhaps\nmade fund managers more confident about the repayment abilities of financial\nstrained corporate houses as well. <\/p>\n\n\n\n<p>This has been the root cause of the on-going debt crisis. <\/p>\n\n\n\n<p>To lesser or greater extent, all market participants are\nresponsible for it. <\/p>\n\n\n\n<p><strong>Here\u2019s\nhow\u2026<\/strong><\/p>\n\n\n\n<ul><li>Investors, in search of superior returns (as compared to those on FDs), went overboard without understanding credit risks. <\/li><li>Fund managers remained complacent about liquidity conditions and extended finances to heavily indebted business houses with the thought that they would be able to easily rollover the debt. Even top fund houses like <a rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\" href=\"https:\/\/www.personalfn.com\/fund\/Aditya-Birla-Sun-Life-Mutual-Fund\" target=\"_blank\">Aditya Birla Sun Life Mutual Fund<\/a>, <a rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\" href=\"https:\/\/www.personalfn.com\/fund\/principal-mutual-fund\" target=\"_blank\">Principal Mutual Fund<\/a>, <a rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\" href=\"https:\/\/www.personalfn.com\/fund\/hdfc-mutual-fund\" target=\"_blank\">HDFC Mutual Fund<\/a>, <a rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\" href=\"https:\/\/www.personalfn.com\/fund\/reliance-nippon-mutual-fund\" target=\"_blank\">Reliance Nippon Mutual Fund<\/a> amongst others seem to have failed in their internal assessment process<\/li><li>Advisers were overzealous in promoting debt funds and liquid funds as an alternative to fixed deposits. <\/li><li>Credit rating agencies failed to timely revise credit ratings of corporate. <\/li><\/ul>\n\n\n\n<p style=\"text-align:center\"><strong>Mutual fund exposure to troubled companies just before the respective\ncrisis came to light<\/strong><\/p>\n\n\n\n<center><table class=\"wp-block-table\"><tbody><tr><td>\n  <b>Group\/Company<\/b>\n  <\/td><td align=\"center\">\n  <b>Mutual fund industry exposure<\/b>\n  <\/td><\/tr><tr><td>\n  IL&amp;FS \n  <\/td><td align=\"center\">\n  Rs 2,130 crore\n  <\/td><\/tr><tr><td>\n  DHFL\n  <\/td><td align=\"center\">\n  Rs 6,252 crore\n  <\/td><\/tr><tr><td>\n  Essel group\n  <\/td><td align=\"center\">\n  Rs 6,500 crore\n  <\/td><\/tr><tr><td>\n  Reliance (ADAG) companies\n  <\/td><td align=\"center\">\n  Rs 2,589 crore\n  <\/td><\/tr><\/tbody><\/table><\/center>\n\n\n\n<p style=\"font-size:12px;text-align:center\">(Source: PersonalFN Research)<\/p>\n\n\n\n<p>If you refer to table above, the impact may not look very significant\nbut it\u2019s inconsistent. Some schemes have lost severely, while others have\nmanaged to come out relatively unaffected. <\/p>\n\n\n\n<p>For example, some mutual fund houses held up <a href=\"https:\/\/www.personalfn.com\/fns\/no-fixed-maturity-for-fmps\" target=\"_blank\" rel=\"noreferrer noopener\" aria-label=\"FMP (opens in a new tab)\">FMP<\/a> redemption proceeds, since Essel Group didn\u2019t honour its debt repayment. In fact, these mutual funds didn\u2019t have any other choice but to allow the promoters of the group time until September 2019 to honour repayments. <\/p>\n\n\n\n<p>Selling shares offered as collateral would have knocked off even\nthe principal amount given the relatively illiquid nature of shares of Zee\nEntertainment (considering the quantum that mutual funds could have offloaded).\n<\/p>\n\n\n\n<p>But some mutual funds escaped this situation as they exited the Essel\ngroup debt fund before the problem inflated to its present magnitude. <\/p>\n\n\n\n<p>Take another example. <\/p>\n\n\n\n<p>The <a href=\"https:\/\/www.personalfn.com\/fns\/how-ilfs-rating-downgrade-will-impact-your-mutual-funds\" target=\"_blank\" rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\">IL&amp;FS<\/a> episode, which unfolded about eight months ago, was an eye-opener for investors. The total outstanding debt of this systemically important institution was a little under Rs 1 lakh crore. Until a few months prior to the default IL&amp;FS enjoyed the highest (\u2018AAA\u2019) rating. <\/p>\n\n\n\n<p>The default affected schemes across fund houses and debt\ncategories. Shockingly, the NAVs of some liquid mutual funds and ultra-short\nterm funds incurred a single loss of anywhere between 3%-5%, thereby erasing\nalmost all the gains that were made in the 8-9 months until then. <\/p>\n\n\n\n<p>As against this, many <a href=\"https:\/\/www.personalfn.com\/fns\/are-you-holding-debt-mutual-funds-with-stressed-assets\" target=\"_blank\" rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\">debt funds<\/a> easily absorbed the shock and nullified it within a couple of months. <\/p>\n\n\n\n<p>Consider this example too. <\/p>\n\n\n\n<p>When a fund house sold <a href=\"https:\/\/www.personalfn.com\/fns\/dsp-mutual-funds-sale-of-dhfl-bonds-heres-what-you-need-to-know\" target=\"_blank\" rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\">DHFL<\/a> debt at a steep discount (as compared to other \u201cAAA\u201d rated instruments), it had immediately grabbed the attention of experts. But within a few months, credit rating agencies downgraded DHFL debt twice. This caused havoc in the debt market with bond prices falling as much as 20%-30% within a week. <\/p>\n\n\n\n<p>Reliance Commercial Finance, Reliance Home Finance (ADAG\ncompanies), Amtek Auto, Jindal Steel and Power Limited (JSPL), Ballarpur\nIndustries; the list of companies that got mutual funds in trouble is lengthy. <\/p>\n\n\n\n<p>Nonetheless, like mentioned earlier, the effects on various mutual\nfunds varied. On April 30, 2019, mutual funds with significant exposure to\nReliance Commercial Finance and Reliance Home Finance marked own their\nexposure. NAVs of these funds fell in the range of 2%-5% in just one day. In\ncontrast, schemes with lower exposure lost only about half a percent. <\/p>\n\n\n\n<p>Are you wondering why?<\/p>\n\n\n\n<p>It\u2019s because depending on the processes fund houses followed,\ntheir exposure to these troubled companies varied. <\/p>\n\n\n\n<p>When the risk component rose significantly, process-driven fund\nhouses estimated that sustaining debt could become difficult to issuers. As\nsome fund houses have issued statements to the media that, their timely exits\ndidn\u2019t reflect their foresight but was a consequence of processes they\nfollowed. <\/p>\n\n\n\n<p>In essence, credit risks can knock doors randomly and avoiding\nthem is almost impossible even for a seasoned fund manager. Nonetheless, a process-driven\napproach, less dependence on concentrated exposures (for generating higher\nreturns), and absence of thoughtless NFOs to garner more AUM have separated\nresponsible fund houses from others.<\/p>\n\n\n\n<p><strong>How to\napproach debt funds at this juncture?<\/strong><\/p>\n\n\n\n<p>Our outlook on funds exposed to papers of private entities, especially those having highly leveraged balance sheets, is that it is better to avoid funds carrying high credit risk (including <a href=\"https:\/\/www.personalfn.com\/guide\/liquid-funds\" target=\"_blank\" rel=\"noreferrer noopener\" aria-label=\" (opens in a new tab)\">liquid funds<\/a>). <\/p>\n\n\n\n<p>Advisers and investors alike should stick to mutual funds where\nthe fund manager doesn\u2019t chase returns by taking higher credit risk. One should assess his\/her risk appetite\nand investment time horizon and shouldn\u2019t ignore the interest rate\nrisk while investing in debt funds.<\/p>\n\n\n\n<p>In times when the policy rates could move\neither way, given the neutral monetary stance, first selecting the category of\ndebt mutual funds becomes crucial.&nbsp;&nbsp;<\/p>\n\n\n\n<p>Investing aggressively at the longer end of the yield curve could\nprove imprudent, even though the RBI has taken an accommodative stance. So,\nlong-term debt funds can encounter higher volatility in the foreseeable future.\nIf inflation moves up, it will limit RBI&#8217;s scope of reducing policy rates\nfurther. Currently, shorter maturity papers are more attractive. <\/p>\n","protected":false},"excerpt":{"rendered":"<p>The current mayhem in the debt market has affected almost all institutional investors. Post demonetisation, inflows in debt funds and liquid funds improved considerably. In October 2016, income funds and liquid funds collectively had an AUM of Rs 10.3 lakh crore which swelled to Rs 11.7 lakh crore within a year. Heavy inflows in debt&hellip;<\/p>\n","protected":false},"author":3,"featured_media":252,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"cybocfi_hide_featured_image":""},"categories":[3],"tags":[],"_links":{"self":[{"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/posts\/251"}],"collection":[{"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/comments?post=251"}],"version-history":[{"count":2,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/posts\/251\/revisions"}],"predecessor-version":[{"id":254,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/posts\/251\/revisions\/254"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/media\/252"}],"wp:attachment":[{"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/media?parent=251"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/categories?post=251"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/wp-json\/wp\/v2\/tags?post=251"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}