Is the Market Experiencing a Debt Fund Debacle? (Includes information about DHFL)
Debt mutual fund investors are worried, given the recent happenings in the market.
The situation began with the IL&FS fiasco and then taking shape with series of downgrades in companies namely Yes Bank, DHFL, Reliance Capital and Essel Group.
The panic situation has been also because most debt mutual fund investors believe these products to be really safe instruments. Therefore, the harsh reality of downgrades and defaults took entire markets by storm.
Therefore, investors need to know the fact that returns generated after the risk free rate will come with an amount of risk. So, on one hand many debt mutual fund instruments do neat the returns of fixed deposits in banks but it comes with the string of risk attached.
The panicky situation began with the IL&FS group being downgraded from AAA to a credit rating of D in less than two months (happened last year in September). This was brought about by the default on its liabilities.
A similar thing happened with the Essel Group lately. Kotak Mutual Fund could not honor in full the money due in its Fixed Maturity Plans (FMPs) to its investors.
This situation also created skepticism in the investor’s community. (Note: However, Essel Group has been provided time till September 30, 2019 to honour all its debt. The promoters are in talks and it is believed that decisions are likely to be taken soon to resolve the issue)
Due to the IL&FS crisis panning out, central government and the Central Bank had to chip in to pacify the investor as well as the corporate community.
Though steps were taken, liquidity constraints still remain. Let us understand this through data that will help our investors to take note of the situation.
Association of Mutual Fund of India (AMFI) has provided for the first time the break-up of net fund positions of all scheme categories post the recategorization of mutual funds. (Note: There are 16 categories of debt mutual funds and a total categories in mutual funds is 36 post recategorization)
The data reflects that debt mutual funds, mainly the medium duration funds and credit risk funds have seen an outflow last month in April 2019. The outflows in each category have been shown below:-
| Type of Fund | Outflows (In April 2019) |
| Medium Duration Funds | INR 531 crores |
| Credit Risk Funds | INR 1253 crores |
Note: Credit risk funds are schemes that invest at least 65 percent of their corpus in securities that are rated AA and below. Therefore, we can say that for this product the risk involved when compared to other similar debt instruments is very high.
Medium duration funds are open-ended funds that invest in instruments with a duration between three and four years. The risk associated while investing in this kind of fund is medium.
Should Investors be Worried Under This Situation?
Analysts believe that outflows from this category might be a cause for concern and affect the demand for commercial papers (CPs).
However, we should understand that most inflows into CPs come mainly from liquid funds which are seeing robust inflows. Say for example in the month of April 2019, net inflows into debt funds was about INR 1.21 lakh crores of which includes INR 89,778 crores inflow into liquid funds.
In a recent interview, Mr. Karthik Srinivasan, vice-president at ICRA said that he estimates that around 3.17 lakh crores of CPs maturing in less than 90 days will see smooth rollovers. Most market participants also believe the same.
The DHFL Situation
Dewan House Finance Corporation Limited, which is a non-banking finance company failed to make a scheduled payment on June 4th, 2019. In fact, funds from DHFL suffered losses as high as 53%.
Around 165 schemes that invested in this stock, registered a fall of around 5%.
A minor section of the investment community probably saw this coming, as DHFL has been suffering from a liquidity crisis before. However, DHFL had not defaulted prior to this.
Conclusion
Though outflows have happened in credit risk and medium duration funds, these have been small sized ones. These funds do not invest in CPs where the maximum pessimism and attention lies.
The liquid funds have been seeing a strong inflow therefore and so, the risks can be rightly managed.
Besides, if you look at the bigger picture, the exposure of all mutual fund houses to papers of companies of DHFL, IL&FS, Essel Group and Yes Bank is a very small portion of the AUM of the total debt mutual funds.
However, schemes and guidelines have been set up in order to resolve the issue. Government as well as the regulatory bodies viz. SEBI and AMFI are keeping a check on the same.
Say for example, in the wake of ongoing rating downgrades, the central bank said that non-banking financial companies (NBFCs) with assets of more than INR 5000 crores must appoint a chief risk officer (CRO).
The primary role of the CRO will be identification, measurement and thereby mitigation of risks.
For investors it is always advisable to research about the products thoroughly before investing. When investing in debt mutual funds, it is extremely important to choose a scheme that matches our investment horizon and risk profile.
The table below can help the investors make an informed choice:-
| Fund | Investment Style | Risk involved |
| Overnight Funds | 1 day | Least risky |
| Liquid Funds | Upto 91 days | Very low |
| Ultra Short duration funds | 3 to 6 months | Very low |
| Low duration funds | 6 to 12 months | Low |
| Money Market Funds | Upto 1 year | Low |
| Short Duration Fund | 1 to 3 years | Low |
| Medium Duration Funds | 3 to 4 years | Medium |
| Long Duration Funds | Greater than 7 years | High |
| Credit Risk Funds | Min 65 percent invested in corporate bonds | Very High |
| Corporate Bond Fund | Min 80 percent invested in corporate bonds | Very High |
| Gilt Funds | 80 percent in G Secs, across maturity | Very High |
| Banking and PSU funds | Min 80 percent invested in banks, PSUs, public financial institutions | Medium |
Happy Investing!