Debt investors feel the pinch after Franklin fiasco highlights risks

The closure of six debt funds by Franklin Templeton Asset Management (India) has shown that fund managers may be taking more risks with investors’ money than the latter had bargained for. Portfolios of shorter-duration funds have been found to hold lower-rated papers. And investors have discovered that the promise of liquidity in an open-end fund could be broken when the going gets tough.

Sanjay Kumar Singh, Business Standard
11th May

Hereafter, investors may turn more appreciative of the humble bank fixed deposit (FD). When a bank makes a loan and it goes bad, the FD investor is not immediately affected (he suffers only if his bank is closed or placed under moratorium). In a debt fund, if a fund manager’s decision goes bad, the brunt is borne immediately by the investor in the form of a hit to the net asset value (NAV).

Investors who thought of debt mutual funds as safe products that give FD-plus returns need to revise their opinion.

Low-risk fund: The only category that perhaps qualifies is overnight funds. These funds invest in papers of one-day maturity and hence do not display volatility.

Moderate risk include:

Liquid funds: They invest in papers of up to 91-day maturity. Even these funds have shown volatility in the recent past (due to, say, sale of papers by another fund). Investors should hold on to these funds through such periods.

Shorter-duration funds: Furth­er up on the duration curve lie ultra-short, low-, and short-duration funds. Until recently, these funds were deemed low-risk. After recent events, investors or their advisors need to check whether these funds have considerable exposure to lower credit quality papers (below AA+). Investors also needs to watch out for longer-duration papers hidden within their portfolios. “These funds could have floating-rate bonds with tenure of, say, five years. But since the interest rates on these bonds reset every six months, fund managers accommodate them in portfolios of shorter-duration funds,” says Nikhil Banerjee, co-founder, Mintwalk.

Money market funds: They invest in money market instruments like certificates of deposit (CDs), commercial papers (CPs) and treasury bills having maturity up to one year. “Not all CPs are safe even if they are rated A1+. Such papers can get downgraded rapidly. Get your advisor to evaluate the quality of CPs in the portfolio,” says Vidya Bala, co-founder, Primeinvestor.in.

Corporate bond funds: Another relatively safe category that investors may consider because minimum 80 per cent of the portfolio must be invested in the highest-rated papers. But do scrutinise the non-AAA portion. Higher the percentage of AAA PSU (public-sector unit) bonds, safer the fund (since the government won’t default). Investors also need to watch out for the presence of pass-through certificates (PTCs). An NBFC could combine the cash flows from many borrowers to create a PTC. If its customers default on EMIs, the fund will be affected.

Banking and PSU funds: This is another category deemed to be relatively safe. These funds invest in bonds issued by PSUs and in bonds and CDs issued by banks. Many fund houses today have funds in this category that invest 100 per cent in AAA PSUs and public finance institutions. “Most of these funds are offering a yield to maturity of 6-6.5 per cent. We expect another 50 basis points of rate cut, so besides this much accrual, these funds could also give some capital appreciation,” says Murthy Nagarajan, head-fixed income, Tata Mutual Fund.

Check for perpetual bonds held in their portfolios. Only if they belong to top-notch banks should you invest. “While you don’t have to worry too much about credit risk, these funds could have some duration-related volatility since their average maturity can range from one to four years,” says Bala.

To overcome duration risk in any of these categories, the investor’s investment horizon should exceed the average maturity of the fund. This will give the fund time to recover from a hit to the NAV due to rising interest rate. If a fund has below AA+ papers, they should not be too concentrated (exposure to a single issuer should not exceed 3 per cent of the portfolio). Savvy investors should stick to portfolios with one-three-year average maturity.

Higher-risk investments: Two categories most retail investors should stay away from currently are longer-duration bond funds and credit risk funds. The former funds hold gilts which could turn volatile. “The government could, on the one hand, face a revenue shortfall. On the other, it may have to provide a fiscal stimulus. It may have to go in for additional market borrowings in the future. If the amount is high, that could lead to a spike in long bond yields,” says Devang Shah, deputy head of fixed income, Axis Asset Management Company.

Credit risk funds (or any fund carrying considerable credit risk) can be avoided. “We don't know wh­en the pandemic will end. If the lockdown keeps getting exte­n­ded, and the pandemic continues to impact lives, it could lead to more downgrades and defaults in lower-rated corporates,” says Shah.

Disclaimer: This information is from a third party—Business Standard—offered through a tie-up to Kotak Securities customers for free for life. This information is provided “AS IS” and “AS AVAILABLE” basis and Kotak Securities Ltd make no representation or warranty of any kind , express or implied regarding the accuracy, adequacy, validity , reliability , availability or any completeness of the information provided herein. The third party content is not created or endorsed by any business offering products or services through it. The provision of this third party content is for general informational purposes only and does not constitute a research call, recommendation or solicitation to purchase or sell any security or make any other type of investment or investment decision. Also, the views and opinions stated in the content belong to Business Standard. Kotak Securities does not uphold nor promote any of the views. These reports do not, in any way, qualify as a Kotak Securities research report.. KSL holds no responsibility of any kind as regard to any discrepancies, errors, omissions, losses or damages. For data reference to any third party in this material no such party will assume any liability for the same. Kotak Securities Ltd and/or any affiliate of Kotak Securities Ltd does not in any way through this material solicit any offer for purchase, sale or any financial transaction/commodities/products of any financial instrument dealt in this material.. Kotak Securities Ltd (including its affiliates) and any of its officers directors, personnel and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this material in any manner. All recipients of this material should before dealing and or transacting in any of the products referred to in this material make their own investigation, seek appropriate professional advice.. The recipient alone shall be fully responsible/are liable for any decision taken on the basis of this material.. No part of this material may be duplicated in whole or in part in any form and or redistributed without the prior written consent of Kotak Securities Ltd. This material is strictly confidential to the recipient and should not be reproduced or disseminated to anyone else.

A few links for further reading

Insecure and uncertain in insurance business as Covid-18 damage claims mount

Insurance companies around the world were sailing smoothly, helped by growth in emerging markets and strong capitalisation. Things changed in late February when markets realised that Covid-19’s impact on insurers could be significant. Insurers are yet to know the full impact of the crisis as governments and regulators nudge them to give moratoriums to policyholders and quickly settle claims too. India’s insurance regulator has set strict deadlines for medical insurers to settle Covid-19 claims. General insurers face damage claims from businesses devastated by the national lockdown to contain the disease. Is insurance secured to survive, Joydeep Ghosh explains

The unravelling

There was a time when pay cuts we see today were a complete no-no; govt and public sector jobs were considered safe, as pay and pensions were both assured. Not any longer, it seems, writes T N Ninan

Quick approval, grace period

The COVID-19 pandemic has brought home the significance of health and life insurance like nothing else earlier. Even those who were blasé about these covers in the past are now looking to buy a new policy or want to enhance the sum insured on their existing ones. Meanwhile, the Insurance Regulatory and Development Authority of India (IRDAI) has been issuing a slew of guidelines to health/general and life insurance companies aimed at easing matters for customers.

Want to get this in your email?