We are in the business of risks and returns. By nature, we are always focused on returns and risks come at the forefront only when the tide is against us. From this perspective, understanding and managing risk is of utmost important, be it in equity or fixed income securities.
In fact, it is more important to manage risk on the fixed income side because we don’t have a liquid and a vibrant bond market as compared to foreign markets. Hence, we have to hold the debt paper till maturity and manage risk associated with it. Thus, managing risk is more important than returns.
Pankaj started with a very basic common sense approach towards managing risk - stringent due diligence of assets, promoters, industry and financial strength of the company. Most importantly, he laid down some thumb rules which AMCs should follow to avoid undue risks.
Here are some important takeaways from Pankaj’s session:
- To avoid influence on decision making, the risk management team should not be a part of investment team.
- There should no exposure to any company rated under AA-. Ratings always lag as they are derived based on information provided by the company. Thus, you can rely on rating agencies only up to a certain extent.
- One should always see a critical ratio which is total debt/total market cap. Lower the number, better the company.
- Cost of debt is always less than equity for good companies
- Downgrades, if any, should be tracked and researched
- Only see long term ratings, short term ratings are of no use
Besides, we should remember the ground realities of Indian markets. As Indian markets are not liquid, any exposure will have to wait till maturity and the company should be healthy enough to repay interest for that long.
For instance, Pankaj cited an interesting case study about DLF Emperio which operates luxury mall in New Delhi. He stressed that how their focus was on cash generated by DLF Emperio and not by the parent company (DLF) or the industry in which they operated. In case of DLF Emperio, the cash generated was 3 times the interest paid to investors and there was a great visibility of the same for the next 5 years.
His session was an eye opener. We got to understand the risk management process of debt funds. Sessions and information like this will help us convince our clients on their concerns of investing in mutual funds.
