By Abhenav Khettry
In today’s age of lightning fast social media updates and forwards, it has become very easy to quickly make anyone a hero or a villain. The lack of fact checking and believing in hearsay, has caused much heartache and sometimes irreparable damage to brand values created over years.
Here I am, trying to talk about one of the latest villains of the lock down: debt funds.
Investors and advisors alike have been very unkind to this Rs 13-lakh-crore mutual fund category, because of one of its sub categories, credit
risk funds, managed by
Franklin Templeton Mutual Fund. However, it will be unfair to blame only Franklin Templeton for the fall out of the current scenario, but still Franklin does deserve the maximum blame for this. Here are the reasons:
- We heard the phrase “managed credit” for the first time after the closure of its six schemes. Never heard this phrase from any other fund house in India.
- Though Sebi had clearly categorized debt funds and had christened a category called “credit risk,” it is surprising to note that six funds of Franklin had to be closed due to liquidity crunch, which they have conveniently called “managed credit.” Credit risk fund category investors would have assumed the risk they were entering into, but it is really unfair on the ultra-short term and low duration fund investors to have their money blocked.
- We can understand a problem with one or two papers in a scheme and for that Sebi had already created side pocketing, which allowed fund managers to continue running a fund, without having to close it because of one bad investment. But closing six funds was clearly a breach in investment process.
- Franklin had already side-pocketed Vodafone and Yes Bank perpetual bonds. This is apart from earlier instances of Amtek Auto’s debacle, among others.
- Franklin’s closure of six schemes from ultra short term fund to their short-term income fund, basically covers all debt funds except for their money market funds like liquid and overnight and their government and PSU funds like banking & PSU and gilt funds. This is quite alarming, that the entire “managed credit” space was vulnerable to liquidity risk. This created a unique problem, where bank lines were drawn and there was no more money available to meet redemptions in the short term.
In a bid to raise cash, Franklin tried to liquidate their holdings in securities like PNB Perpetual Bonds and Gujarat Coastal Power, driving down their prices and pushing up their yields. Due to daily marked to market NAV regulations, other fund houses holding similar papers, also had to value their bonds at lower prices, thus amplifying the panic in the market and pushing NAVs down.
Other fund houses that have faced a fate similar to Franklin Templeton in debt are: UTI, BOI AXA, Principal, Aditya Birla Sun Life, PGIM and Nippon India. They have all lost money for investors on a one-year basis in their different debt funds.
Having said this, there have been many other fund houses, that have managed the debt space well and have delivered returns of over 6% on a one-year basis in their
credit risk funds, medium term funds, short term funds, low duration funds and ultra-short-term funds.
These fund houses are: IDFC, Kotak, Axis, HDFC, SBI and ICICI amongst others. From an AUM basis, these fund houses have done a good job giving investors a good investment experience in the debt category.
So why are debt funds a friend indeed of investors?
- Debt funds allow investors to generate returns, higher than prevailing bank fixed deposit rates from a portfolio of Government, PSU and good corporate papers.
- They provide ample liquidity on a daily basis to any corporate or individual investor, more than they could ever manage to generate on their own, with similar papers.
- Even bank fixed deposits have penal clauses and are not exactly as liquid as debt funds. The investor ends up losing a lot of penal interest for premature withdrawal, which when factored in will make fixed deposit returns even more unattractive.
- Bank fixed deposits carry reinvestment risk and in a falling interest rate scenario, the investor won’t have an option but to reinvest at a lower yield. A debt fund, benefits in a falling interest rate scenario, where its bonds can generate extra returns by an increase in bond prices. Off course the opposite is true in a rising interest rate scenario.
With surplus liquidity in the banking system of Rs 6 to 7-lakh-crores, returns on bank fixed deposits will only decline further. The gap in the yield of a one-year FD and a low duration fund of one-year maturity is almost 400 bps. If you evaluate the underlying portfolio you will find many familiar PSU, banking and corporate names as issuers. These are household names and have been in business in most cases for over 25 years.
Also, another important point that debt fund investors must realize is that India has a very large institutional debt market, comprising of banks, insurance companies, various provident funds, foreign investors and
mutual funds. If a sound company is traded or quoted at an unusual yield, the market will be quick to lap it up. Domestic demand for debt is always high and usually any dislocations in prices usually revert to mean within a few days. Most provident funds and insurance companies have monthly flows which need to be deployed and they are all looking for papers which meet their criteria at the best possible price.
As a debt fund manager, if you pick the right quality companies with able management and good cash flows, there will be a buyer for your paper, providing ample liquidity. Currently there is a large spread between government securities and corporate papers (even PSUs with sovereign guarantees) and this spread wont last long and will eventually revert to mean.
As a debt fund investor, invest in a scheme with a good portfolio with a horizon of three years or more and you can only stand to gain. They will stand by you in times of need.
(The author is the founder and Director of Vyana Wealth Management in Kolkata.)