By R Balachandran
The year 2019 can best be described as “annus horribilis” (horrible year, in Latin) for debt mutual funds, to borrow a phrase used by Queen Elizabeth. There was an endless litany of woes, in the form of defaults by ILFS, DHFL, Reliance Capital, Altico and many more. Even supposedly safe investments in “ring fenced” special purpose vehicles secured through annuity from NHAI, defaulted.
Mutual fund honchos may whine that as a percentage of the overall Assets Under Management, the amount of defaulted securities was insignificant, but they should try telling that to investors in their schemes, who lost a good part of their investment overnight. Some of the biggest names in the mutual fund industry with pedigreed backers like HDFC and Kotak, apart from several other well-known fund houses like UTI, Aditya Birla Sun Life, Nippon India, Tata etc., bit the dust.
While the default in some of their schemes and the associated negative publicity in the media would have given many a fund manager sleepless nights, it is the end investor who paid the real price, by having their investment marked down.
The new year 2020 too has not begun well, with many debt funds taking a hit on their exposure to Vodafone.
Who managed to dodge the bullet?
Did any mutual fund manage to dodge the many bullets that struck the industry in the recent past? Surprisingly there has been a small minority of fund houses which avoided default in any of their schemes. IDFC Mutual Fund and ICICI Prudential Mutual Fund stand out. Since it would appear to be in poor taste to indulge in public schadenfreude, both the funds have not particularly highlighted their achievement nor appeared to revel in the misery of the rest of the industry.
How did they pull it off?
IDFC Mutual Fund appears to have taken a straightforward strategy. The yield to maturity (YTM) in their funds is in general lower than that of their peers. “Lesser risk-lesser return”, in a reverse play of the “high risk-high reward” strategy appears to have been IDFC’s approach. IDFC Mutual Fund’s debt fund portfolio is every conservative investor’s delight. Even their credit risk fund portfolio’s profile is akin to that of a short-term debt fund of other fund houses with consequent lower YTM compared to the credit risk funds of others.
ICICI Prudential Mutual Fund
ICICI Prudential has taken bolder/riskier bets, with comparatively higher returns while managing to dodge almost every bullet that hit the industry, the exception being an exposure to Essel group, which too has been repaid since.
While the deliberations of the fund’s internal risk management discussions are not in the public domain, one presumes that a healthy disdain for external “AAA” ratings would have stood them in good stead, in navigating the treacherous terrain that the corporate debt market has turned out to be, in the last one year.
The fund house was recently in the news for having invested its own funds in its credit risk scheme. While this is heart-warming, investors need to be cognizant of the fact that there is no guarantee in the event of losses in the scheme. The fund house merely gives comfort that they would swim or sink together with the investor!
Outlook for debt fund investors
It’s a minefield out there. The “safest” scheme, the overnight funds backed by collateral of government securities yields a mere 4.8-5%. With the latest Consumer Price Inflation figure at 7.5%, investors will lose money, post inflation and tax. Liquid funds without undue credit risk, again yield about 5-5.5%. Gilt funds which gave supernormal returns of 10-14% in the last year, by taking on high duration, may now be in uncertain territory.
If inflation readings continue to trend high, gilt funds may give up their returns, and perhaps even result in capital losses for investors. On the other hand, the recent virus scare emanating from China and the resulting fall in oil prices are positive for bond prices. Outlook for gilt funds may therefore, to an extent, track the trajectory of the spread or containment of the coronavirus!
Banking and PSU debt funds and corporate bond funds have yields in the range of 6.5-7%, with relative safety. Some credit risk funds offer better returns of 9-10%, at a much higher risk.
With the skewed income tax regime which heaps tremendous tax benefits on debt mutual fund investments, while charging the marginal rate of tax on returns from direct investment in treasury bills and government securities, bank and corporate fixed deposits, investors in higher tax brackets may have no choice but to continue with their debt mutual fund investments. Diversifying the portfolio across a few fund houses and across a few schemes within each fund house, is a possible risk mitigation strategy.
In general, the math is straightforward: compare the yield to maturity of schemes in a particular category. For example, liquid fund or short-term debt fund of various fund houses: the ones which have higher YTM are likely to have taken riskier exposure. The conservative investor can select a lesser yielding scheme, and the aggressive investor can go for higher yields, while staying away from fund houses which have slipped on almost every banana skin that came their way in the last few months.
(The author is a fixed income investor and erstwhile corporate banker)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
