Credit risk funds invest in corporate bonds having lower credit ratings with a view to generate higher accrual income and capital appreciation due to positive re-rating. Since these companies are usually rated below AAA, there is a risk of default.
Debt markets have been volatile in the past year. What is your near term debt market view?
Markets have been in a turmoil in the last few months in anticipation of a rate hike, discouraging changes in global markets and oil prices. However, the negative returns were like the bottom of the downturn. It was market pricing in all the negative news. We expect the ride to be slightly less bumpy hereon. As the coming year is an election year and there has been no positive change in external factors, volatility is likely to persist in debt markets.
While investing in credit risk funds there is always a fear of default. Do you think this worry is justified?
In the last 12 years, there have been just 4-5 instances of default. Though you cannot deny the risk of default, fund houses follow stringent processes to mitigate such risks.
What role do credit ratings play in security selection?
We take credit rating as a starting point. However, we do not rely on credit rating agencies. We have developed an internal credit rating model along with our partners T Rowe Price. Through the model, we arrive at our own internal rating for the instrument. This rating defines whether we will purchase the security and if we do then at what price.
What is the process involved to select a corporate bond?
For shortlisting potential securities, we first study the qualitative data before analysing the quantitative data.
We first evaluate the promoters and the board of directors and the quality of governance. Evaluation of its auditors follows this to ensure that company’s business is audited thoroughly. The next stage includes reviewing the quality of management. In the final stage, we take a holistic look at their relationship with the entire supply chain right from bankers and other creditors to suppliers. Only if the company passes these primary checks, do we analyse its financial statements to understand important debt parameters like leverage, profitability and growth.
Lower rated papers tend to be illiquid. How do you ensure that the scheme does not come under pressure in case there are sudden redemption requests?
To manage liquidity, we invest a certain amount of the portfolio in high rated papers that are easily saleable. Additionally, the fund house has set limits on maximum permissible investment by an individual in the scheme.
In the current scenario, which schemes should advisors recommend to their clients?
Advisors should recommend schemes based on their client’s risk profile. In the near term, as we do not see any fall in Interest rates, we believe that investors with low risk appetite should invest in low to short duration funds. Investors with moderate risk appetite can consider credit risk funds for investments as these funds can offer superior returns compared to short term funds at a slightly higher level of risk.