What are the lessons for fund managers after the recent events in debt funds?
Recent months have been unprecedented for the economy as well as the debt markets. The credit environment in India has been deteriorating since the past couple of years – beginning with the default by IL&FS and its group companies. This was aggravated by the slowing GDP growth and the impact of the slowing economy on Non-Banking Finance Companies. Mutual Funds invested in such companies have had to deal with a tightening credit and liquidity environment, especially in respect of NBFCs who have exposure to MSME space. These times have emphasized the importance of a robust and systematic credit selection and investment process as well as the need for diversification within portfolios to manage credit risk and liquidity.
Debt funds are seen as riskier than equity funds in the current economic scenario. Your comments.
The volatility in debt funds is a recent market driven phenomenon. These are unprecedented times with large parts of the economy shut for almost 2 months in the national lockdown. In such economic conditions, it is inevitable that businesses are impacted significantly which stress will transmit to debt funds who are directly or indirectly exposed to these businesses. However, debt funds still measure lower on all risk and volatility parameters vis-à-vis equity funds. The developments in recent months have shown that debt funds also carry risk, albeit lower than equity funds, due to their investments in companies that would get impacted by broader market conditions.
Many distributors feel that it is better to stay away from credit funds. In this category, investors get only a few basis points higher return if everything goes well, while the downside risk is significant. What is your advice to them?
Investors should have a portfolio of funds diversified across asset classes based on their risk appetite, investment horizon and financial goals. Most funds investing in corporate bonds carry an element of risk. The advisor should help the investor diversify this risk based on the investor's risk appetite. High credit risk funds (funds investing in predominantly lower rated papers) can be part of the portfolio based on an assessment of the investors risk appetite and should not in most cases be the core fixed income product that investors have. Besides, the investor and the advisor should review the underlying holdings which information is available publicly.
What will be the key driving factors for debt funds?
Debt Funds are meant for investors with a lower risk appetite and / or the lower risk allocation portion of the portfolios. Debt funds would continue to be relevant with the investors laying greater emphasis on the credit research framework, portfolio construction and the investment process. The income generation with low volatility of debt funds would be an important determinant of attraction for debt funds.
Some of your debt funds had exposure to IL&FS and DHFL. How did you deal with that exposure?
Incidentally, both DHFL and IL&FS Financial services were rated AAA and A1+ respectively at the time we invested in these papers. Subsequent events in the economy and market led to a deterioration in the performance of these companies. We have revisited the credit research framework and evaluated our risk management processes to ensure that we are able to avoid, to the extent possible, such events in the future. Both the papers have been marked down to zero in the portfolios.
How do you plan to regain the confidence of distributors post these credit events?
Principal has been proactively engaging with investors during these past months. We have increased the frequency of disclosure in our debt portfolios and strengthened our risk management processes covering both credit analysis and portfolio construction and incorporated insights from these events into our portfolio construction and investment process.
Many distributors complain that short duration debt funds taking credit risk go against their clients’ risk appetite. While many have called for SEBI to revisit the categorisation in debt schemes, what can fund houses do at this point?
The categorization of debt funds by SEBI has created categories based on duration and credit rating of the issuers in the portfolios. The categories based on duration of the portfolios have no restrictions on the credit quality of the investments in the portfolio. Investors and advisors should study the portfolios (available at least on a monthly basis) before investing in such funds.
Sometimes fund factsheets do not mention the debt scheme’s entire holding in a company. For instance, a scheme can have exposure to little known subsidiaries of a parent company. In case of a credit event, while investors can easily identify their scheme’s holding in that well-known parent company, they cannot identify the exposure in the little known subsidiaries. What can be done in this regard?
The Monthly Portfolio disclosures, apart from the factsheet, is mandated by SEBI and is usually available by the 10th of the following month on the Fund’s website. This disclosure provides details on each investment in the fund’s portfolio. Investors should refer to this section for portfolio details Principal also publishes a note on select issuers that we hold in our portfolios on a monthly basis.
Some distributors argue that debt funds should release fund factsheets more frequently. They argue that since some of the investors use debt funds to park money for less than a month, there is a need to assess the debt fund portfolio on a weekly or fortnightly basis. Your comments.
While the holdings in the fund do not change as frequently, we provide fortnightly disclosure of our debt portfolios on our website.
Sometimes a debt fund factsheet mentions yield to call, which is not the same as yield to maturity. The yield to call mentions when will the fund management sit with the issuer of the debt instrument to take call on resetting the yield on that paper rather than the maturity. What is your take on this practice?
Our factsheets mention yield to maturity and we do not have any such debt securities across any of our portfolios with only yield to call. Further with only call option it is the right of the issuer to decide on whether to exercise the call option or not. Investors do not have the right.
Why should distributors recommend debt schemes of Principal Mutual Fund?
We believe a strong investment philosophy and a robust investment management process are essential to build and manage a portfolio. Principal Mutual Fund has a disciplined investment approach that takes acceptable risks, whilst attempting to minimize volatility in the portfolio. We follow stringent risk policies to optimize the risk & return proposition for investors. We focus on the three pillars of safety, liquidity and quality in our debt portfolios. We are currently running portfolios that lay equal emphasis on each of the abovementioned critical pillars.
Can you briefly talk about debt fund strategies in Cash, Ultra Short Term, HE, BAF and Equity Savings Fund?
Each of our debt funds and debt portions of hybrid funds have a clearly laid out product strategy in line with the category profile and investor expectations.
Principal Cash Management Fund:
The fund is managed with an extremely conservative credit and maturity approach. Primarily with a mix of high quality CDs/CPs and high amount of liquid assets in form of TREPS and Sovereign T bills. CP investments are cherry picked based on adequate due diligence and surveillance with adequate credit risk spread else avoided. In current environment low risk is prioritized over returns. Once the credit environment normalizes the credit strategy would be reviewed.
Principal Ultra Short Term Fund:
The fund is managed with a conservative credit strategy with modest maturity profile with investments primarily in 1 month to 2 yr spectrum. The NCD portion is entirely invested in AAA assets as of 31st March. Adequate liquidity in form of TREPS and sovereign T bills are kept to meet periodic redemptions and take advantage of market movements. In current environment low risk is prioritized over returns. Once the credit environment normalizes the credit strategy would be reviewed.
Principal Hybrid Equity (Debt Portion):
Managed with an active bond strategy across Money market instruments, Corporate bonds, SDLs and gsecs. Overall for past few months the average maturity has been kept modest in range of 2 to 3yrs and recently gilt exposure has been increased considering the RBI support and rate cuts which form a conducive environment. The portfolio of Corporate bonds is mostly AAA/AA+/AA with average maturity of papers ranging from 6 months to 5 yrs.
Principal Balanced Advantage Fund (Debt Portion):
The debt portion is managed primarily as a low duration cum short term strategy with primary exposure to short term corporate bonds and money market instruments and tactical exposure to government securities.
Principal Equity Savings Fund (Debt Portion) is managed primarily as a low duration cum short term strategy with exposure mainly to corporate bonds and commercial papers to give accrual to the portfolio.
