IL&FS cri­sis: How real is the risk in debt funds?

Con­tinue to stay in­vested even if your debt funds are hit by IL&FS down­grades un­til we know what its turn­around plan is go­ing to be

Mint Asia ST - - Views Otherviews - BKY AYE Z AD EA. DAJANIA

Debt fund in­vestors have been in a tizzy this past month over the down­grades in credit rat­ings of In­fra­struc­ture Leas­ing & Fi­nan­cial Ser­vices Ltd (IL&FS) and some of its sub­sidiaries. A to­tal of about 33 funds (across liq­uid, ul­tra short-term bond funds, short-term bond funds, credit risk funds, etc.) had these com­pa­nies in their port­fo­lios; the cu­mu­la­tive value of these hold­ings in these funds added up to ₹ 2,308 crore as on Au­gust-end 2018, ac­cord­ing to data from Crisil Ltd. At least three fund houses had to mark down some of their schemes’ port­fo­lios by about 25% to 100% of the value of the un­der­ly­ing se­cu­ri­ties as IL&FS and some of its com­pa­nies ei­ther saw a sharp fall in their credit rat­ing or didn’t re­turn the prin­ci­pal.

The short-term scrip of In­fra­struc­ture Leas­ing & Fi­nan­cial ser­vices Ltd saw its credit rat­ing fall to a rat­ing of D on 17 Septem­ber 2018 (in­di­cat­ing de­fault), down from a rat­ing of A4 (as on 8 Septem­ber) and A1+ (as on 6 Au­gust). Sim­i­larly, IL&FS Fi­nan­cial Ser­vices Ltd’s short-term pa­per’s credit rat­ing fell to ‘D’ on 17 Septem­ber, down from A4 (as on 8 Septem­ber) and A1+ (19 Fe­bru­ary 2018).

Ac­cord­ing to the mu­tual fund in­dus­try val­u­a­tion norms, rat­ing agen­cies Crisil and ICRA pro­vide scrip prices daily to all funds across all se­cu­ri­ties that funds have in­vested in. But when a se­cu­rity turns be­low in­vest­ment grade (Bbb-rat­ing), fund houses value se­cu­ri­ties as per their in­ter­nal val­u­a­tion norms.

This time, as per the in­dus­try’s con­sen­sus, fund houses marked down the se­cu­rity’s value by 25% when the scrips rat­ing went be­low in­vest­ment grade rat­ing (Bbb-rat­ing). The net as­set val­ues (NAVS) went down to that ex­tent. Later, when some scrips de­faulted, some funds wrote down the en­tire value of their hold­ing, while a few other funds wrote down about 50%. If you are an in­vestor in such schemes, should you with­draw?

No mu­tual fund is risk-free

Con­trary to pop­u­lar be­lief, debt funds are not risk-free. Though they are less risky than eq­uity funds, debt funds too come with two kinds of risk—in­ter­est rate volatil­ity and credit risk. The former hap­pens when in­ter­est rates move—specif­i­cally up­wards—that causes a debt fund’s NAV to move. The lat­ter hap­pens when an un­der­ly­ing in­stru­ment’s credit rat­ing drops or de­faults on in­ter­est and prin­ci­pal re­pay­ments.

Joy­deep Sen, founder, Wi­sein­, said in­vestors haven’t yet un­der­stood the risks in debt funds. “His­tor­i­cally, there have been in­stances where if a prob­lem oc­curs with any un­der­ly­ing se­cu­rity in a debt fund, ei­ther the as­set man­age­ment or the spon­sor com­pany bought the said trou­bled pa­per from the debt fund and paid the money back to the MF scheme. But in the last few years, this has not hap­pened. Whether it is JP Mor­gan In­dia As­set Man­age­ment (Amtek Auto Ltd), Taurus As­set Man­age­ment Co. Ltd (Bal­larpur In­dus­tries), or in the present IL&FS case, fund houses did not take the hit on their own books. They let the scheme take the losses and that is why the NAVS in all these cases fell,” said Sen.

How to man­age risk?

Al­though debt funds are ben­e­fi­cial, man­ag­ing risks is tricky. A se­nior an­a­lyst at a for­eign bro­ker­age house said that if you do not like tak­ing too much risk, keep your in­vest­ments in credit risk funds (that in­vest in low-rated pa­pers) to a min­i­mum and in­vest a ma­jor­ity of your in­vest­ments in schemes that fo­cus on high-rated bonds (cor­po­rate bond funds). Thanks to the re­cent clas­si­fi­ca­tion ex­er­cise that the ₹ 23 tril-


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