Debt mutual fund schemes must improve their risk management processes.

In a recently concluded summit, the Securities And Exchange Board of India (SEBI) and the mutual fund advisory committee agreed unanimously on this point.

Officials familiar with the development stated to the media that the SEBI is pondering on making it compulsory for the fund houses to form an internal risk evaluation committee. This is to be comprised of key officials of the Asset Management Company (AMC) and external risk management consultants. Mutual fund trustees will monitor the performance of this panel. On the condition of anonymity, the officials said, “An independent committee will be better able to carry out an in-depth analysis of the AMC’s investments."

To safeguard the interest of mutual fund investors, SEBI—from time to time—has imposed many disclosure norms on mutual funds. However, experts had rated these disclosures too basic to draw any meaningful inference from. Taking this feedback positively, the capital market regulator is set to introduce norms for a more robust tagging and categorisation of debt schemes. People familiar with this development briefed media about SEBI’s views on the subject, “Investors need to understand the nature of risks when they invest in debt schemes. For instance, the risk associated with a corporate bond fund that invests in AAA-rated papers is totally different from that which primarily invests in A-rated papers. The sub-categorisation needs to spell out these risks more clearly,"

In the past, mutual funds have failed in tackling the deteriorating credit quality problems. In the quest of generating higher returns, they invested in low-rated debt papers. But when this was sharply downgraded, fund houses had no response time. This resulted in real losses. Many of them learned nothing from their past mistakes. As on August 31, 2017, the aggregate mutual fund exposure to “high-risk-high returns-credit opportunities” stood at a staggering Rs 1 lakh crore. Mutual fund houses have been investing aggressively in debt papers issued by Non-Banking Financial Companies (NBFCs). On the backdrop of sagging economic growth, the risk of capital loss in debt funds may become a reality. Many brokerage houses have independently voiced their concerns on this subject.

In February 2017, an independent credit rating agency——India Ratings and Research——slashed Long-Term Issuer Rating of Ballarpur Industries Limited’s (BILT) from ‘IND D’ from ‘IND BBB-’. Moreover, the agency also reduced the rating of its Non-Convertible Debentures (NCDs) and Commercial Paper (CP) to ‘IND C’.

‘IND D’ denotes the debt papers are in default or will make a default soon. The rating of ‘IND C’ indicates the chances of default regarding timely servicing of debt are high.

Taurus mutual fund had gulped debt instruments of BILT in 4 of its debt schemes. All the schemes suffered steep losses ranging from 7.2% to 11.8% in a day. That’s been the quantum of losses.

If you think this was a one-off instance; it’s not.

In 2015, JPMorgan Mutual Fund blew up investors’ capital by investing in debt instrument of a debt-laden company Amtek Auto Ltd. Two of its schemes, JPMorgan India Short Term Income Fund and JPMorgan India Treasury Fund, had an aggregate exposure of Rs 200 crore to Amtek Auto’s debt securities.

When CRISIL downgraded the long-term rating of Jindal Steel and Power Ltd (JSPL) to ‘BB+’ from ‘BBB+’ and from ‘BB+’ to default status, fund houses received a huge blow. According to some media reports, Franklin Templeton Mutual Fund offloaded troubled bonds of JSPL at a loss of Rs 512 crores —nearly 1/3rd of its acquisition cost.

Should you stop investing in debt oriented schemes?

Of course not.

But don’t consider them risk-free either.

What should investors do?

• Follow a holistic approach towards debt fund investing.
• Don’t invest more than 20% of your debt portfolio in long-term debt funds.
• Your investments in debt funds should be in line with your personalised asset allocation that takes into account your financial goals and risk appetite.
• Don’t speculate on macroeconomic developments. Clearly, define your investment time horizon.
• Choose right debt funds for your portfolio.
   

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