‘Every downgrade is not a default’

By Morningstar |  03-06-19 | 

Credit funds have been in the line of fire due to the credit events in debt market.  Lakshmi Iyer, CIO – Debt & Head of Products at Kotak AMC recently spoke with Kaustubh Belapurkar, Director – Manager Research, Morningstar Investment Advisers India, at the Morningstar Advisor Forum.

What is your sense of the events transpiring in debt market and what is the way forward?

If I have to give you two sides of the spectrum, from euphoria we have gone into excessive caution. If excessive euphoria was unwarranted then excess precaution is also unwarranted for money managers, advisers deploying money and investors. The fear of exodus of money is preventing fund managers to deploy money more confidently. This is leading to a reduction in yields. Looking at the reduced yields, investors are shying away from investing in low yielding products. This is becoming a vicious cycle.

Given the downgrades that have happened so far, do you see a huge risk on the horizon?

I think the entire episode in debt market has been blown out of proportion. Advisers allocate money in debt funds from a three-year perspective. No credit risk fund has delivered negative return over a three- year period. Our mind is conditioned by recency bias. The credit risk space is still fledgling. The assets in credit risk funds are not even Rs 1 lakh crore yet.  These funds need some time to flourish. The category holds promise. We need to appreciate what the situation is, where did it originate from and where is it leading to. The cause and effect of one over the other is very different. Plaguing the entire industry based on a few events is not fair.

Investors are taking money out of credit risk funds. Do you see normalcy coming back into the segment?

The confidence is broken. The credit spreads have widened. When the Lehman Brothers collapsed in 2008, the credit spreads exploded. At that time, there were hardly any credit funds in the industry. The excesses were unwounded rapidly. The difference this time is that the liquidity in the overall banking system has worsened. Because of that even the high-grade assets have been affected. Today, overnight rates being at 6%, markets are deploying money at less than this rate. Even high-grade commercial papers are getting placed at 7%. It will take a while for the confidence to come back. One way could be through monetary policy rate. The credit spreads in terms of valuations are looking attractive. You can cheery pick the funds but completely abstaining from the category because of the recent events is not advisable.

Should investors stay put in the funds which have incurred losses?

The panic in terms of fund flows has subsided. The only comfort we can draw now is that the BJP has won with a decisive mandate and the trajectory for rates is clear. Globally, things are looking somber and that is giving an opportunity for yields to come down. This soft environment coupled with softening economy (GDP numbers are expected soon) will give some sense of urgency to policymakers to reduce rates. I think the panic is arrested. We are already seeing a huge amount of flows in ultra-short funds. After June 22, when bonds with maturity of over 30 days will be marked-to-market in liquid funds, the sanity check will be enhanced.  In this market, staying put is equal to investing. Don’t exit. Educating investors at every point of time is very important to assuage the pain points. Investors are more than eager to listen. Advisers should not get carried away by noise.

Medium term funds have lost a big chunk of flows because investors didn’t expect or were not aware that these incidents will happen. What are your thoughts on managing investors expectations?

Securities and Exchange Board of India (SEBI) categorization has made a lot of compartmentalization. Barring the credit funds category, the compartmentalization largely revolves around duration. That was one step to get the industry on one standard. We need to see where more we can compartmentalize. Advisers need to be choosy about fund selection and educate investors about the risks associated with various debt funds.  In equity, we have four broad categories but in debt we have 12 categories which is needed. The investor has to evolve her mindset beyond a traditional product like bank fixed deposit and embrace debt funds.

Investors consider debt funds riskier than gold. But debt funds have not delivered negative returns over one-year period, whereas gold has fallen in value. Mutual funds are push products. Advisers are doing a noble job and they should not quit hopes. Conviction has to be from within. If investors say that only the risk portion of their portfolio should be deployed in equity, then advisers should not recommend them credit risk funds. Give them PSU bond funds, short term bond or ultra-short bond funds. Don’t sell false hopes to clients.

Fund managers have a natural tendency to be ahead of others but within the investment mandates. If the fund is giving you highest yield, it is a risk. Investors have a tendency to chase returns. We need to educate investors about this. Every downgrade is not a default. Funds will bounce back.

Any roadblocks that can further aggravate the situation in debt market?

If the liquidity situation in the market is not adequately addressed, then a liquidity crisis morphing into a solvency crisis will not take time. Though I don’t see that kind of scenario because there is deleveraging happening as we speak. Corporate India is not spending. Investing cycle is on a lull stage. Non-Banking Financial Companies are not lending meaningfully. All of this leads me to suggest that there may not be significant casualties. Downgrades are inevitable. I’m not worried about downgrades at this juncture. I’m worried about liquidity situation remaining unaddressed for a long time. I’m looking forward for this monetary policy decision.  Addressing liquidity situation will restore the confidence in markets.

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Amit Arora
Jun 13 2019 10:37 PM
 In continuation of the earlier comment on FMPs by Kotak AMC , it is not acceptable that the Fund Manager now cites liquidity of the stock as reason for creating side pockets and "protecting investors interests". Any fund manager should be aware of Sizing and Liquidity risks prior to making an investment. Its very easy to modify terms when things don't go your (reckless) way and hide it under the garb of investor interest.
sandeep deshmukh
Jun 5 2019 04:40 AM
 kotak mf is in the dock for poor investments in fmps. but i do not see you asking them any tough questions. infact you have given them a platform to preach to others. how very independent of you. have a nice day!
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