Our analysts' verdict on 5 Credit Risk funds

Oct 28, 2022
Associate director of manager research Himanshu Srivastava and senior research analyst Nehal Meshram share their views.

The five funds have been presented according to the date of analysis. The name of the funds link to more details on the fund and a summary note by the analyst. Read what the Analyst Ratings signify.  

HDFC Credit Risk Debt Fund

  • DATE OF ANALYSIS: July 2022
  • ANALYST NAME: Nehal Meshram
  • FUND MANAGER: Shobhit Mehrotra

Mehrotra’s investment philosophy is centered on building a portfolio with safety and liquidity. This is achieved through a disciplined and focused risk-controlled investment process.

The investment team begins the process by formulating a macro outlook and then determines appropriate exposures through credit and duration play.

In terms of credit selection, the team focuses on factors such as company management, financial strength of the promoter group, and corporate governance standards. This is followed by rigorous quant analysis such as leverage, coverage, and solvency ratios. It also leverages the expertise of fundamental equity research to select individual debt securities. Due diligence of the lower-quality credits is reviewed more closely within a shorter time gap, and the managers consider bonds for investment where the financial strength of the issuer is analysed by the major rating services.

Duration is determined through assessment of various macro factors, yield-curve positioning, and interest rates. Mehrotra maintains a moderate duration of 2.5-3.0 years. The fund is well-diversified with around 55-60 instruments across sectors. Individual security exposure is capped at 5%, and the size of the bets decreases progressively as a firm's financial strength and market cap decrease.

The in-depth understanding of companies has helped Mehrotra in identifying securities offering attractive spreads. The fund invests at least 60-65% of net assets in bonds rated AA and below. The fund has higher exposure in AA+ and AAA bonds, which makes for a quality portfolio. It typically maintains 30%-35% in AAA and G-Secs, 55%-60% in good-quality AA bonds, and 5% in A and below rated instruments. Overall, the fund's credit rating is tilted towards low risk.

A highly experienced risk-management team is well-integrated into the investment process. The team stacks up well on the credit research front and the execution of the fund has been good, with the portfolio having the right mix of high-quality and high-yielding bonds, generating superior returns over the medium term.

Nippon India Credit Risk Fund

  • DATE OF ANALYSIS: July 2022
  • ANALYST NAME: Nehal Meshram
  • ANALYST RATING: Neutral (Direct), Negative (Regular)
  • FUND MANAGER: Sushil Budhia

The investment process is research-based, and credits and structures are well-researched for yield enhancement. However, the approach did not have the desired results through recent credit cycles.

Credit selection at absolute high yields and attractive spreads without carrying high duration underpin this offering. Economic, credit, and liquidity analysis form the pillars of the investment process. The team incorporates the views of key external and in-house economists on factors such as gross domestic product growth, inflation, fiscal deficits, and trends in government borrowing, which are important for managing this fund.

The change in the ownership of the fund house has resulted in a better process. They have taken incremental measures for every fund to ensure adherence to its investment mandate. But we have taken a cautious approach, as the past years have been challenging for the fund, as it saw few downgrades during the recent credit cycles. Until last year the portfolio was quite illiquid in nature and the size of some bonds were significantly high owing to passive breach, resulting from large redemptions during the 2020 liquidity crisis. There has been an increased focus on the concentration risk but it's quite and early days to conclude the major risk management shortcomings that surfaced in the past have been completely fixed. We need more time and an opportunity to observe how this fund handles another risk-off market before gaining more confidence.

Further adding to concerns, the fund also saw a change in the portfolio manager, and we are yet to build conviction in him and his execution skills.

The focus on lower credit quality is critical in this strategy. The fund is focusing more on managing concentration risk and maintaining a diversified portfolio. The last two years had been a testing time for the fund as there was a lot of concern owing to the size of some individual lower-rated bonds which went up significantly because of the passive breach. The fund witnessed significant outflows following the credit default events in NBFCs, because of which the concentration risk increased in the portfolio in 2020-21.

The exposure to single A rated bonds was also quite high until last year but we have seen a gradual enhancement in the portfolio's quality.

To ensure liquidity in the portfolio, the strategy is to ladder the portfolio in terms of maturity while maintaining modified duration in the defined range. The fund avoids taking duration risk in the portfolio and typically maintains a moderate duration up to 2.0 years. To remain in this duration range, the manager ensures he does not invest in corporate bonds with a duration of more than 4.0 years. 

SBI Credit Risk Fund

  • DATE OF ANALYSIS: July 2022
  • ANALYST NAME: Nehal Meshram
  • ANALYST RATING: Bronze (Direct), Neutral (Regular)
  • FUND MANAGER: Lokesh Mallya

The fund's strategy is to take significant credit risk while minimising interest-rate exposure. It invests across the capital structure with a bottom-up investment process and applies a combination of quality and liquidity filters to its universe. This helps eliminate speculative companies with excessive debt or negative earnings.

Investments in credits are not based on interest-rate movements, reflecting its passive duration approach. The team uses various qualitative and quantitative parameters and puts a lot of emphasis on companies' management, business, and financial health. It also focuses on the covenants in detail, which helps protect from downside scenarios. It also uses the analysis of sell-side research and credit-rating agencies to form a view on the creditworthiness of companies, but to a limited extent. The credit committee then reviews the rated securities, and the approved securities are assigned credit and tenor limits. While constructing the portfolio, the team has the flexibility to implement trades with reasonable leeway to express its views.

The fund invests primarily in high-yielding fixed-income instruments, with at least 65% of the portfolio invested in securities rated AA and below. With credit risk higher in the portfolio, managers maintain lower duration risk in the range of 2.0-3.0 years. To maintain duration within the band, the manager invests in corporate bonds below 5.0 years maturity.

The managers invest across the capital structure rather than simply going down the credit curve. They have invested in some high-yielding structures backed by promoter guarantee, loan against shares, cash flows, and so on. Examples are Latur Renewable Private Limited and Prestige Projects. The portfolio also includes a few perpetual bonds from Punjab National Bank, Union Bank, and Indian Bank. When choosing perpetual bonds, the investment firm takes the approach of selecting large PSU banks.

The risk-management team periodically reviews the portfolio to ensure the managers adhere to the guidelines. We believe that the flow of an idea/information is effective and fits nicely with the process in place.

Kotak Credit Risk Fund

  • DATE OF ANALYSIS: March 2022
  • ANALYST NAME: Nehal Meshram
  • ANALYST RATING: Bronze (Direct), Neutral (Regular)
  • FUND MANAGER: Deepak Agrawal

The fund house has a tight structure put in place to evaluate the credit matrix and take a transaction-based approach while investing. The strategy invests primarily in good-quality high-yielding assets and takes small duration bets. The fund maintains a portfolio maturity in the range of 1.5-2.0 years.

The manager seeks to identify duration bets through macroeconomic factors by incorporating the views of internal and external economists. The credit analysis is divided into banking, NBFCs, and manufacturing debt and further demarcated into three buckets based on the strength of the business, management, and corporate-governance standards. Following a recent wave of downgrades in 2018, surveillance has increased significantly. The NBFC and housing finance industries are being tracked more closely. They also keep a close check on sponsored debt and evaluate the asset/liability profile on a monthly basis.

The team also leverages the expertise of the equity team at Kotak AMC and Kotak Bank. The qualitative assessment is followed by rigorous quant analysis that takes into account leverage, coverage, and solvency ratios. While constructing the portfolio, the manager uses a proprietary model to determine the amount of exposure he can take in each issuer.

The manager runs the strategy with low to moderate duration and invests in high-yielding assets to increase accrual income. The fund is conservatively managed relative to its category peers, and its risk management has stood the test of time. The manager avoids companies with poor disclosures, and this has helped the fund avoid bonds like the IL&FS AAA rated bond, which was downgraded in 2018. The fund did have some exposure to NCDs issued by Contingent Drug Co Ltd, an entity held by Zee Group, which also saw downgrades; however, the company eventually made an early repayment and the impact was unwound.

The portfolio is largely concentrated in AA rated issues and is well-diversified portfolio comprising roughly 50-60 securities, each with a 5% security limit. Given that the fund is more focused towards safety and liquidity, the manager does not compromise on the quality of the portfolio to generate higher yields. Hence, some of the investments in A rated credits are strong and mainly in PSU bonds such as UP Power Corporation.

There is also an independent risk-management team that ensures the limits are adhered to. The presence of an experienced investment committee is helpful and makes the investment process more holistic.

ICICI Prudential Credit Risk Fund

  • DATE OF ANALYSIS: January 2022
  • ANALYST NAME: Himanshu Srivastava
  • ANALYST RATING: Bronze (Direct), Neutral (Regular)
  • FUND MANAGER: Manish Banthia

This fund is characterised as a credit fund with its positioning leaving little room for duration plays. Here the team prefers investing in stable companies having higher certainty of returns than targeting uncertain higher returns. Hence security selection, portfolio construction, and liquidity management are of paramount importance.

The investment approach is research-driven. The credit team scouts for companies that have strong management with proven track records and are backed by financially robust promoters having good corporate governance standards. This is followed by rigorous quantitative analysis in which various financial ratios are considered. A credit is added in the investment list only after getting an approval from the board and the risk management team.

Another defining aspect of the investment process is the team's preference for safety over outsize return. Hence it is ready to forgo high-yielding investment opportunities which could expose the fund to unwarranted risk. The idea is to focus on achieving long-term maintainable and consistent performance rather than chasing short-term trends. Broadly the investment process is well-defined, robust, and research[1]driven.

With credit as the central theme, Banthia is mindful of the risks that accompany credit-oriented strategies. While credit and liquidity risks inherently tag along with such strategies, he also considers concentration risk as one of the major risks to the portfolio. He therefore tries to construct the portfolio in a manner which reduces their impact on the fund. For instance, exposure to single issuers in the portfolio does not increase beyond 5%. To ensure adequate liquidity, the team adopts a ladder approach to investing. That way it makes sure that there's no concentration of maturities in any timeframes, and the maturities are spread out over quarters. The security selection is largely bottom-up, with traces of top-down play to weed out certain sectors.

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