Make debt funds safer

NEW DELHI: Recently, a journalist asked me whether investors need to be more careful with debt funds. My reply was, ‘Can they, really?’ When the

Essel Group

issue came to light, it took our research team days of analysis and follow-ups with fund houses before we could wrap our heads around the problem. There were name changes, missing information, and several cross-holdings to decipher. Can we even imagine the plight of a regular investor? The proportion of individual investment—retail and HNI—in debt and debt-oriented products is not small. It was 36% in March 2019. With increased awareness about asset allocation and tools like SWP, this percentage has only been going up.


Impact of redemptions
The funds that held bonds which were impacted or downgraded adhered to regulatory norms. However, the impact of write-offs from downgrades or defaults was harsh. Funds had to exit better-rated bonds to meet redemption requirements, raising concentration in riskier bonds. In the past eight months, funds’ exposure to risky bonds has risen from 7-8% to 30-40% due to large redemptions. This was followed by a downgrade or default and a sudden markdown in funds’ NAV, leaving retail investors stumped.

Were we better off in the era of separate NAVs for retail and institutional investors? While there were anomalous practices associated with two NAVs, the current system victimises the retail investor. Has the regulator thought about the impact of redemptions on retail investors where the portfolio is filled with risky or illiquid bonds?

Inter-scheme transfers

Concentration risk

comes to light, but inter-scheme transfers seldom do. These are a legitimate way to transfer assets from one scheme to another within the fund house. But the practice remains opaque. A few months ago, my team came across bonds shifted from a very short-term debt scheme to a

credit risk

scheme. This was just months before the IL&FS crisis. The fact that risk was shoved under ‘credit risk’ and removed from a pro-institutional product does shake one’s confidence. If a bond had been identified as risky, it shouldn’t be in any fund. While the regulator has always frowned upon inter-scheme transfers, the current norms require that these be disclosed, and no justification is needed. How will a retail investor learn of such transfers and understand the reasoning behind them?

Does categorisation help?
Sebi’s efforts to get fund houses to invest the way they classify their schemes are appreciable. However, while Sebi chose to classify most debt fund categories according to duration, there was no mention of the level of credit risk they can carry. Credit risk funds and

corporate bond

funds are the only categories where rating criteria is used. This means that ultra short-term or short-term funds are free to take risks. However, the questions of whether risks should be allowed in short-term funds and what is the fallout of such risks have not been considered in any categorisation. We have seen many ultra short or short-term funds under stress in the recent spate of downgrades/defaults. Many retirees or income-seeking investors are advised to invest in short-term accrual funds and opt for SWPs. Even an earnest adviser, may be in for a rude shock when there is a spate of downgrades or a sudden concentration risk that impacts such seemingly low-risk funds.

These are but three issues that have come to light. One can’t help but wonder what other problems are lurking in the shadows. Fund houses are aggressively marketing debt funds. These are positioned as having ‘lower risk’ and for ‘regular income’. But recent events have shown that debt funds are far from being retail-friendly products.

It is imperative that the regulator understand the pain points of retail investors. Fund houses cannot be expected to provide the inputs. Finding solutions by working with fund houses and rating agencies, along with inputs from the advisory community, is the need of the hour.

(The authour is head --

mutual fund

research, FundsIndia.com)