What are the lessons for fund managers after the recent credit events in debt funds?
The most important lesson that series of credit events taught me is diversification. A fund should have diversification not only at the issuer level but at the group level also.
NAVs of Axis MF’s debt schemes have not taken a beating amid the recent credit events. Is it because of diversification?
At Axis MF, we have followed the principal of diversification since beginning (from 2009).
For instance, we keep 5% exposure to AAA rated paper largely in non PSU PFI sector. Similarly, for AA and A rated instrument, our exposure is limited to just 3% and 2% in a single issuer, respectively. We do not go beyond 7.5% on AA group level exposure.
Some debt funds did not take a significant exposure to a particular asset or group. However, due to redemption pressure the schemes had to sell its liquid assets. Consequently, percentage of their holdings in the troubled papers increased. What can be done in such a scenario?
Diversification is one of the solutions. Suppose a scheme has 2-3% exposure to a paper. Following redemption pressure, even if AUM of the scheme halves, the exposure in troubled assets would not go above 4-5%. Also, if you have such minimal exposure, heavy redemption is unlikely.
Second, debt funds should have adequate liquid instruments to handle redemption pressure. For example, even our credit fund has 5-10% cash and around 25% in AAA assets.
Moreover, not mixing duration and credit risk also helps. If I want to take the risk of duration then I would prefer it through AAA curve, not through AA assets.
In an opinion poll run by Cafemutual last month, most distributors said that they would stay away from credit funds, and recommend only short-term debt funds to their clients due to the series of credit events in debt markets. What is your advice to them?
Short-term debt funds do make sense. However, I do not think there is credit deterioration at large. Only a few issuers have seen liquidity crisis in the last 6-9 months.
Now, the AA spreads have significantly widened. Before the IL&FS crisis, the AA assets were trading at 50-75 basis points higher over AAA. But today they are trading 150-175 bps higher over AAA assets. So, if you ask me, from a risk reward perspective, this is the time to buy credit funds.
Most advisors have started believing that debt funds are as risky as equity funds. Your comments.
If the investment horizon is known, the risk appetite is known and the right product is advised, I do not see higher risks from debt funds.
For example, if the investment horizon is between 1 month and 6 months and a duration fund is advised to the investor then the risk that the investor perceives will be higher. However, if investors is advised a liquid fund or ultra-short term fund, then it would not be a problem.
What will be the key driving factors for debt funds?
I do not see crude oil prices as one of the risks, as crude prices are likely to remain quite steady. Geopolitical risk, global slowdown, and Budget are going to be the key factors to watch out for in the near-term.
In the run-up to the Budget, what are the changes that you have made in your portfolio?
We were long in most of our portfolios pre-elections, because the levels were quite attractive. Today, we are going quite low on duration, as the RBI had already delivered 75 bps rate cut in 2019. And in the next 6 months, we see only one more rate cut of 25 bps.
What we like at this point is 2-3 years corporate bond segment and AA assets.
Which category of funds should distributors recommend to their clients in current markets?
Advisors can go with short-term and medium-term category funds. For investors having good risk appetite, credit funds also make sense.
