Reserve Bank of India (RBI) has found that fund houses have been taking undue risks in their debt portfolios by increasing exposure to downgraded debt securities.
In its Financial Stability Report released by the RBI in June 2016, the banking regulator has found that the exposure of debt oriented mutual funds to corporate bonds that were downgraded in the last six months increased from 1.6% as on September 2015 to 1.8% in March 2016.
A rough calculation shows that debt funds have an exposure of close to Rs. 14,000 crore to downgraded paper as on March 2016.
“While investments in corporate bonds offer higher returns, the risk premium may not be commensurate with elevated corporate stress as reflected in a large number of rating downgrades,” cautioned RBI in its report.
Overall, the exposure of debt funds to corporate bonds as percentage of their AUM increased by 4% between September 2015 and March 2016, states the report.
In a recent public forum, SEBI Chairman U. K. Sinha had cautioned mutual fund houses about credit risks in debt funds and advised them to be careful while investing in debt instruments. Expressing his concern over the recent Amtek Auto episode, he said that fund houses should manage their debt portfolios more proactively. He advised fund houses to develop expertise in analyzing credit risk on their own.
SEBI has instructed fund houses to reduce reliance on rating agencies while investing in debt instruments. In addition, the market regulator has asked fund houses to set up in-house credit risk assessment mechanism before investing in fixed income securities. SEBI had said, “In order to ensure that MFs/AMCs are able to carry out their own credit assessment of assets and reduce reliance on credit rating agencies, all MFs/AMCs are required to have an appropriate policy and system in place to conduct an in-house credit risk assessment/due diligence before investing in fixed income products.”
The regulator has tightened debt fund investment norms. SEBI has mandated fund houses to reduce exposure in single issuer (individual company) from 15% of NAV to 10% of NAV. However, fund houses can increase this exposure to 12% of NAV after getting trustee approval. SEBI has also reduced exposure limit to a single sector to 25% of NAV from the current 30% of NAV. In addition, the exposure limit to Housing Finance Companies (HFCs) has been brought down to 5% of NAV from 10% of NAV.
