Excess of anything is bad. This tenet holds true in our daily lives as well as to a large extent in the financial arena too. For instance, if you have excess of sweets you might develop a condition wherein your body does not produce enough insulin or the cells do not response to insulin that is produced. This results in serious ill effects on your health. Similarly, when financial products are tweaked to make them more complex and sophisticated due to financial exuberance, it turns detrimental to the investors’ financial health. Complex financial products may have appeal due to their aesthetic value, but when it comes to delivering returns, they falter either due to very high risks (occurring due to unwarranted financial innovation) or imprudent fund management. Another example worth mentioning here is debt mutual funds; as the characteristic of the portfolio held by them determines, the investment proposition it offers. In the recent past it has been observed that many mutual fund houses in their debt mutual fund schemes have been taking large exposure to debt instruments from a selected few sectors, thereby exposing its investors to high risks.
Citing this over exposure debt mutual funds which often bankroll builders, finance firms and struggling businesses like aviation, the capital market regulator - Securities and Exchange Board of India (SEBI) has asked fund houses to refrain from taking overexposed positions in any single sector. Recently, the capital market regulator SEBI told several fund houses, though verbally, that their new fund offerings would be cleared only after they promise not to put more than 30% of the money in a particular industry. Debt mutual funds constitute well over 60% of mutual funds' (MF) Assets Under Management (AUM).
SEBI is yet to come out with final guidelines on exposure limits. It is also unclear whether the proposed rules will apply to existing schemes as well. And if existing schemes are kept out, then the New Fund Offerings (NFOs) will be at a clear disadvantage. If existing debt mutual funds are not asked to reduce their investments, which are concentrated in a few sectors, their yields will be much higher than the new debt mutual funds with capped exposure limits.
Several fund houses including JP Morgan Mutual Fund, UTI Mutual, Indiabulls Mutual, Religare, Sundaram Mutual Fund, BNP Paribas Mutual and DSP BlackRock, among others, have applied for NFOs of open-ended funds over the past six months. These funds, according to industry sources, could raise anywhere between Rs 4,000 crore and Rs 8,000 crore during NFO phase. Approvals are still awaited for some of the NFO plans.
We are of the view that, SEBI has taken steps in the right direction in order to curtail the overexposure to certain sectors by the debt mutual funds. Certainly overexposure to a few sectors or debt instruments exposes investors to high risk. However, in some cases overexposure by the fund is well compensated by commensurate returns generated by the fund. Thus, investors while selecting debt mutual funds should also look into the portfolio characteristics as well and the consistency with which returns are generated and track record apart from knowing their investment time horizon.
Moreover, we also think the decision to cap the exposure limits of debt mutual funds should be levied on both - new as well as existing mutual funds, and not only on new funds, in order to avoid any disparity and induce a risk control mechanism. Debt mutual funds provide an important diversification to one’s mutual fund portfolio since it provides exposure to a different asset class. Moreover, it shields one’s portfolio from the volatility of the equity markets.
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