Your debt mutual funds will soon be less risky   Jul 25, 2012

In its efforts to reduce debt mutual funds’ overexposure to specific sectors, the Securities and Exchange Board of India (SEBI) may, on the recommendations of the Mutual Fund Advisory Committee impose a sector cap on the debt mutual fund schemes. At present there is no such sectoral cap. Each fund house decides how much it will invest, in which sector. The proposal to impose a sector cap on the debt mutual fund schemes has been raised after the SEBI observed several debt funds, especially Fixed Maturity Plans (FMPs), were taking huge exposure in specific sectors, raising worries about systemic risk.

The advisory committee has recommended a cap on debt schemes’ exposure to any sector at 30% with an aim to reduce exposure of debt schemes to non-banking finance companies (NBFC), as they have the largest exposure, followed by banking and public sector undertakings (PSU).

We are of the view that, imposing a sector cap on the debt mutual fund schemes will bring in diversification benefits to the investors. Moreover, a cap of 30% is quite sufficient to derive any opportunities available under a particular sector. And at the same time the particular debt mutual fund scheme will not be over exposed to a particular sector. For instance, if 75% of a fund’s investments are in metals & mining, the fund would be dependent on metals & mining to deliver returns. But if there is a sectoral cap, the returns that the fund will generate will come from different sectors. So, say the fund invests 30% in metals & mining, 30% in banking, 20% in engineering and the rest maybe in pharma and FMCG. This will result in the returns getting spread across multiple sectors along with the risk.

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Jul 26, 2012

Without any sectoral cap there is concentration of risk which makes FMPs and other debt funds riskier and susceptible to the poor performance of overexposed sectors and it may lead to systemic risk. With sectoral cap there will be diversification and dispersal of exposures and hence spread of risk. The return will not be sensitive to the poor performance of the over exposed sector(s). This is much like banks/FIs having sectoral caps as well as Single and group borrower credit exposure limits. I think individual company caps are already their for MFs investing their corpus. With sectoral and individual company exposure limits only the very purpose of investments thru' MF (i.e., Diversification) will be achieved.