Credit risk fund assets have witnessed a precipitous fall of 64% from Rs 79,644 crore in April 2019 to Rs 28,530 crore in August 2020. Blame it on the slew of downgrades/defaults that came as a huge disappointment to investors. Not only did this hurt their hunt for higher yield but in some cases, investments got stuck too, adding to the environment of distrust.
Dinesh Ahuja, fund manager at SBI Mutual Fund, explains what went wrong with this category and shares his advice on how investors should navigate debt funds.
Some mutual funds took a battering because of the liquidity crunch, defaults and rating downgrades. What made SBI Mutual Fund relatively immune to these shocks?
I would put it down to a robust process of evaluating credit.
While Securities and Exchange Board of India, or SEBI, mandates single issuer exposure to 15% of the assets under management, we restrict our exposure far below this number. For instance, we do not buy more than 3% of the AUM in paper that are rated below AA minus. Each fund is managed according to a template that defines what a fund manager can and cannot do. These parameters have helped us assess and mitigate risk.
How did you go wrong with Reliance Home Finance?
In the case of Reliance Home Finance, the business was good, but we went wrong in assessing the management. They siphoned off money into other group companies. These events can occur in the future due to market situation. For instance, a few companies are facing a turbulent time due to external events such as the lockdown and an overall fall in economic activity. Prior to the pandemic, one could have done detailed research and drew comfort in the business but events that are uncertain could change everything.
When you don’t get an exit in the secondary market, you are stuck with such instruments.
Investors coming in these funds need to be aware of these risks.
Nevertheless, we have developed internal risk-mitigating factors in terms of limiting exposure to a single paper.
On that note, tell us your biggest learnings from this episode and the mayhem in the credit risk space.
Over the last 5-7 years, credit risk funds grew in size.
Incrementally, we have received far more inflows than what we would have received a decade back. When you get excess flows, you venture into spaces where you have not been before. That is how the market grows. While a bank can have Non-Performing Assets, or NPAs, when mutual funds venture into that space, there is a possibility of ‘NPA’ in the scheme.
External analysis is just a starting point in our analysis of credit. The company might be rated AAA by an agency, but we will do our internal due diligence. Post DHFL and IL&FS episodes - we did not have exposure to them - we made our internal templates more stringent.
Your investments in Reliance Home Finance of January 2020 maturity, where you had written down the exposure to zero. Have you reached a resolution around this?
We had to write down the entire value of that bond. We have filed a petition in the relevant court to take a hold on their assets. We are awaiting a resolution on this.
Is it suitable to invest in credit risk funds at this juncture?
Timing of entry and exit in credit risk funds is not advisable for novice investors. They should first understand the risks. For instance, investors should know that dynamic bond funds and gilt funds carry duration risk. One can allocate based on the risk appetite and time horizon. While investors exited in panic from credit risk funds in April 2020, that was the best time to invest in such funds. The spreads have compressed by 200 basis points now compared to April 2020.
In 2013, the 10-year G-Sec went up to 9%, investors panicked and redeemed. Once you exit, you book losses. Investors who stayed through that volatile period and when yields came down subsequently, those who stayed put made money.
Nowadays, the cycles across various asset classes have shortened. In a 3-year time frame, you might see interest rates move up and down. You might see credit events happening every three years. If one remains invested for three to four years, there is no need to time the market. Instead of timing the entry, one should understand the unique risks involved in each fund category.
You invested in some real estate bonds. How do you view them in this economic uncertainty? Do you see this will likely compress rental yields further?
Yes, rental yields could come down because of the current scenario. We are drawing comfort from the promoter backing the management. While there have been some challenges in raising money in the last three to four months for the real estate sector, the companies we have invested in have been able to raise money in these tough times also. They are sitting on cash. Their current rental yields are far lower than where market yields are. Even if the market yields correct to a certain extent, they can cushion this fall in rental yields. They have enough cash to service debt for one year.
Term spreads are very attractive now; should one shift to longer duration?
Yes, term spreads are attractive. We are allocating money to the longer end of the curve in our funds. From an investors’ perspective, I would reiterate that they should not switch from short term to duration funds just because the yield curve is steep. If the investor has already allocated money to say short term, gilt and duration funds they should not move in and out of these funds. They should let the fund managers decide the allocation.
Are dynamic funds a better option for investors since the fund manager can take tactical calls to capitalize on the evolving trends?
Invest from a three to four-year perspective in dynamic funds. We have been aggressive in terms of changing average maturity and calls when required. In the long-time frame, we have been able to deliver superior risk-adjusted returns in our dynamic bond funds and have outperformed passive investment strategies in fixed income.
If one wants to build a debt portfolio now, how should she go about it? What categories of funds would you recommend for someone with an investment horizon of three to five years?
Investors should ideally hold a mix of medium duration, credit risk, dynamic bond and gilt funds after ascertaining their risk appetite and time horizon. For investors who don’t wish to take duration or credit risk, Banking and PSU Funds can be a good option.
