Mutual Fund debt schemes have a problem when it comes to finding paper to invest in to. Most portfolios are debt issued by NBFCs, Banks, Housing Finance Companies & Financial Institutions. In addition they have some illiquid ‘holding’ company papers that are backed by promoter shareholdings or structured finance papers backed by loans.

There is a proposal to cap the sector limits ( http://www.thehindubusinessline.com/markets/stock-markets/managers-raise-alarm-as-sebi-plans-limit-on-mfs-debt-exposure/article7924089.ece)

This is a welcome move. The mutual funds in debt have a high exposure to the NBFC/Housing Finance sector. When the going is good, no one minds. What happens is that these entities are continuous borrowers with no hope or expectations of ever bringing down their borrowings. It is in their nature to borrow, lend and make a spread. So, in essence, every maturing paper has to be replaced with another one. In a sense they are perpetual bonds, with some procedural routines. The MF universe is a big source of finance for these lenders.

So, if a limit is brought on exposure to NBFC/HFC/Banks/Financial Institutions in aggregate, it will mean a dearth of paper for the MFs. On the other hand, if the limit is high, it means that the risk to the investor gets high. There is a talk of increasing the limit, subject to the highest credit rating. Here, I have a view. All credit rating agencies are NOT the same. I would hesitate to look beyond CRISIL and ICRA. It is a personal view.

The other big issue is that most mutual funds do not have credit analysts in their fold. Dealers have become fund managers and they go by name recognition / credit rating/ peer behaviour.  So, the first thing SEBI should be doing is to see if the MFs have dedicated credit analysts. And there has to be an independent credit review for investments. The Board of Trustees of the MF have to wake up and stir the pot. We know that they are not involved in the operations, but they are supposed to have guidelines in place for appropriate risk management. I do not see the Board of Trustees having this kind of qualifications. It is time SEBI knocked out the Trustee structure and put the onus squarely on the AMC CEO/Investment Committee and the sponsor.

In the meanwhile, debt schemes go on and survive by an element of luck and serendipity. Amtek was a third wake up call. SEBI is sleeping yet. The first wake up call was when Templeton was bailed out by the sponsor. Then the Lehman crises saw a chain of defaults. SEBI still kept smiling. Now it is time they wiped the grin off their face and did something. If the industry has to shrink, so be it. Have credit experts review the framework.

It is likely that a transition period will happen where MFs could be forced to park a lot of money in Bank deposits. But so be it.

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5 thoughts on “THE RISK in Debt Mutual Funds

  1. Sir what is your view of credit risk in liquid funds? Can they be considered absolutely safe? I know there could be return variation based on interest rates but the question is more on credit risk..

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  2. After the amtek issue i have stopped investing in Long Term Debt MF. I can’t keep on tracking what bonds they buy and sell. Faith is the issue.

    Only holding Liquid for bad time

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