Credit quality matters in debt funds

By Morningstar |  09-12-15

NavneetMunotNavneet Munot

Executive Director and CIO, SBI Mutual Fund

Credit is bottom-up, just like equities.

You cannot take a call that it has been credit funds that have done well or accrual funds that have over a longer period. Let me give you an analogy. REITs have been the best performing asset class in the U.S. delivering 9% over the last 15 years. But within that, you had a lot of people who lost their pants when the sub-prime crisis took place. So if you take that broader call and then put money in an asset class, you can get into trouble if you've not done the proper bottom-up research. The experiences over the last couple of months have reinforced that belief.

You can take a macro calls – we took one to stay away from global commodities both in our equities and bond funds. Having said that, it's completely bottom-up. It's the intensity of research, looking at the management, the individual company business model, and the governance.

India does not have a have a strong bankruptcy law where you can predict the probability of default. And you can't really get the loss, given that default is highly unpredictable and very, very difficult. So that creates a bigger challenge.

Liquidity is another challenge. And these aspects have to be built in when you are building your portfolio. Look at the problem British Petroleum had in the U.S. The bond may trade at 85. An investor may take the view that BP is going to survive. They may face some penalties but it’s not the end of the story. He will buy at 85 and make money if the company survives. In India, you don’t see that. It’s either like Rs 100 or straight zero. The liquidity aspect creates another dynamic.

On top of that, running an open-ended has its own set of challenges.

That's why I think the intensity of in-house research is far more important and critical than going by the rating.

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