Define your risk before you invest in debt mutual funds
Debt mutual funds have been in the news for the past six months and there seems to be no respite here.
Debt mutual funds have been in the news for the past six months and there seems to be no respite here. With the exposure to Essel group companies, many funds having exposure to them will find it difficult to repay the investors in full. We have seen this happening with exposures to multiple companies in the past like Ballarpur Industries, Amtek Auto, Jindal Steel & Power and more recently with IL&FS.
Usually, there is a clause in the lending agreement which states that if the value of the collateral security falls below a certain level, then either lenders have a right to sell the shares or force the borrower to pledge some more shares. Neither of this happened in the case of Essel group companies as the mutual funds had come to an agreement with the promoters that they will not sell their shares till 30th September 2019. The question which comes to mind here is the fiduciary duty of the mutual funds towards the investors and whether they should have honored the terms of the lending agreement.
The primary issue that I would like to highlight here is the risk in debt investing. Most of the investors/distributors & advisors selling it to end investors consider debt investments as risk free and compare it with bank fixed deposits or saving schemes of the government.
Taking credit risks in some of the debt fund categories is absolutely fine at the mutual fund level and some of the corporates might default but then the risks should be clearly defined and communicated to the investors. Just like banks will have some NPA’s, the mutual funds will also have some investments in corporates which will default or defer the repayment. The portfolio allocation also needs to be looked at in detail. Large exposures to a particular corporate group could be more riskier and it is better to have a very well diversified portfolio in credit funds across many corporates.
If the primary goal of the investor is preservation of capital and earning a reasonable return on it, then the overnight and liquid fund categories should be his investment universe. If the investor wants an extra return of 100-150 bps compared to bank fixed deposits or liquid funds, then they should be willing to take the credit risks associated with credit risk funds.
(The author is fund manager, PPFAS Mutual Fund.)
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