Off-late the market has been behaving very abruptly. This has resulted in advisors getting numerous calls from investors regarding the health of their portfolio, particularly if you have high exposure to otherwise safe debt mutual funds.

A slew of bad news regarding the default on the repayment obligation from few high rated companies have resulted in investors getting jittery about their investments.

In this blog, we seek to discuss what went wrong for debt mutual funds and what an investor should do amidst such circumstances.

Read on!

The credit rating agencies have downgraded multiple names in the past six months, and this has sparked concern among investors who have a high allocation to the debt asset class.

Investors are entering into a panic selling mode and liquidating their entire allocation, but is that required?

The experts don’t think so!

How Did it Start?

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It all started in September last year when IL&FS defaulted on its repayment obligation. Many mutual funds had exposure to IL&FS, faced default on their payment to investors (both institutional and retail).

The matter amplified when the issue of Dewan Housing Finance Corporation Ltd (DHFL), Zee Group of companies, and companies associated with Reliance Capital came to limelight, declaring stress in servicing debt obligation.

The latest addition to the list of companies was Yes Bank that corrected massively in a matter of one week, post its quarterly results.

These issues resulted in many mutual fund companies rolling over their FMPs (Fixed Maturity Plan) with some of them allowing part redemption, instead of full redemption.

When mutual funds started delaying the redemption of funds by investors, the investors’ confidence got shattered about the safety of debt funds. Downgrades and possible defaults of large companies kept investors on tenterhooks.

For example, DHFL, which happens to be one of the largest NBFC in India, was downgraded by CRISIL – India’s leading rating agency multiple times in 2019. The rating for DHFL fell from being an investment grade to speculative grade for its short-term borrowings due to the tightening of liquidity in the company.

So, to put it simply, yes few debt funds are in trouble due to their exposure to such companies’ instruments. But that should not be the way an investor should think of the situation. Instead, an investor should think about what he/she should do to salvage the situation?

Before talking about what can be done in the situation, let us first capture some misconception about debt funds in the mind of investors.

Misconception About Debt funds

An investor believes that debt funds are entirely safe and is shielded from any risk. But this isn’t absolutely true.

Yes, it’s true that debt funds are safer compared to equity and hybrid funds, but they also have a few risks associated with them. 

Even an investor who is probably aware of the slew of risks associated with debt mutual funds such as interest rate risk, credit risk, etc. would not have faced a situation where their investments in debt funds became extremely volatile. 

So the situation is more to do with the approach of an investor.

What Should an Investor Do Amidst this Situation?

Before executing any selling decision, an investor should analyze the portfolio of the debt fund he/she is exposed to.

An investor should ideally see the total exposure to companies like IL&FS, Essel Group, Yes Bank, DHFL, and the likes. This exposure should be divided by the total assets under management. The exposure to the stressed assets is much below a few percentage points.

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Study the Scheme and Portfolio in Detail

An investor should look at the scheme they are invested in and should figure out the risk associated with those schemes. After the categorization exercise by SEBI, it is easy for investors to understand the kind of risk related to a scheme category.

Investors should look to understand the investment strategy and risks involved by carefully analyzing the portfolio of the scheme.

Decision Based on the AMC

Investors who are associated with large AMCs may choose to continue with their investment. This is because these companies have been through multiple rough phases in the past and hold a rich experience.

But the investors who are invested with a mid-sized AMC that has significantly high exposure to stressed assets may look to exit the investment after conducting due diligence mentioned above.

Conclusion

To conclude, we can say that debt funds are going through a rough phase currently. Particularly the FMP and credit risk category.

But as an investor, you should look to remain invested after conducting due diligence of the portfolio and the fund. For FMP and credit risk funds, you can’t do much, until it attains maturity, but you may choose to take a cautious exit decision for credit risk funds.

Why has the market always shown to recover after a fall?

Again, let me tell you that market ups and downs are part of investing. And exiting your fund is not always the best option.

For other categories of debt fund, we believe an investor can hold onto his/her investment after studying the portfolio and assessing the exposure to stressed assets.

Disclaimer: The views expressed in this post are that of the author and not those of Groww