The credit crisis which engulfed debt funds over the past two years, starting with ILFS Group default, has been exacerbated by the black swan event of COVID-related lockdown in several parts of the country over past few months. As a debt mutual fund investor how should you pick and choose funds in this new landscape?
A very positive outcome of this crisis has been several significant regulatory changes for debt funds – be it on investment, valuation or market related. Investors should be aware of these changes and take these additional points into consideration before investing.
Segregation: One of the key distress points for investors was that when a steep credit event happened and there was a significant valuation hit, the funds did not have an option to provide exit to investors while ensuring they do not miss out on recovery. SEBI guidelines now enable funds to provide segregation as an option. If this option is enabled on the debt fund you invest in, then the AMC may decide to segregate the downgraded exposure from the rest of the portfolio. In such an eventuality, you can exit from the balance exposure while continuing to have a claim (ownership) on the segregated units and any future recovery would accrue to you as an investor at the time of the event. The condition is the downgrade should be to below investment grade or default. So, do check if the debt fund you invest in has an option for segregation.
Safety of liquid funds: There has been significant changes to investment guidelines around liquid funds. These funds now need to mandatorily hold 20% of their assets as liquid assets defined as cash and cash equivalents and government securities like T bills. Liquid funds also need to have a graded exit load up to 7 days. The load is uniform across all mutual funds. This has reduced a lot of hot/volatile money coming into these funds for very short period like one or two days.
Change in valuation guidelines and the haircut matrix: Earlier there was no uniformity on valuation norms for any default or downgraded (below investment grade) debt security. AMCs had to ensure fair valuation which could be interpreted differently by different AMCs. Now AMFI has prescribed a standard haircut matrix which is followed by the valuation agencies and has made the valuation more predictable. Investors and their advisors can now understand the valuation impact better. However, AMCs still can do their own fair valuation if they disagree with this valuation. The Valuation policy of every AMC is mandatorily uploaded and available on their website. This can be reviewed if required.
Detailed disclosures of portfolio: A recent SEBI guideline now makes it mandatory for mutual funds to declare their full debt portfolio on a fortnightly basis on their website versus earlier requirement of monthly basis. This gives more clarity on how funds manage their portfolios intra-month. Not only this, now AMCs also will have to declare the yield at which each security in the portfolio is valued. Earlier, only Portfolio Yield (also called YTM) was declared. This gives more information security wise and helps in attribution (understanding how the fund is generating their returns).
Tighter investment norms: These include tighter sector limits, restriction on investment in unlisted commercial paper or corporate debt, and tight limits of investment in structured and credit enhanced debt. A minimum criterion has been prescribed for equity share cover for LAS (Loan Against Share) NCD structures at four times.
All these norms are expected to make debt funds less risky.
Every crisis leaves its mark. The positive outcome from the current credit crisis has been tighter, clearer and safer norms. Investors should continue to invest in debt funds as per their risk appetite and to meet their financial goals.
(Bekxy Kuriakose is head- fixed income at Principal Asset Management.)
