The stuff of dark noir came alive for mutual fund investors last fortnight when a storied fund house decided to freeze six of its debt funds, prompting me to recall a line from Jaws, a whopper of a scary movie — “You’re gonna need a bigger boat”. Indeed, the need for a larger or a safer playing field for the average debt aficionado was never so acutely felt as now.
The fund house in question has alluded to the challenges posed by an inimical credit climate, which took a turn for the worse over the past few months.
The forces unleashed by the coronavirus, resulting in a nationwide lockdown, have compounded the problem. Yields have spiked and liquidity stands severely reduced. The winding-up of the six funds is, thus, aimed at preserving value and securing an exit for their unit holders.
To cut a long story short, the present day environment is generally dissuading fund managers to liquidate a section of securities held in their portfolios. Borrowing continuously in order to take care of redemptions is not a good idea in so far as investors are concerned. However, a tendency to borrow and pay is quite likely to perpetuate in today’s stressed scenario.
The debt market today is marked by negative impulses generated on the corporate bond front, uncertainties emanating from the NBFC sector, plans by many companies to rejig their debt obligations and holding of unlisted debt securities that draw little or no buying interest.
Investors now need to have a fair idea whether the companies held by their fund managers have access to adequate finances and can actually service their existing debt.
Remember, fund houses are already faced with enormous liquidity-related challenges because of the lockdown. Mark-to-market losses (in the context of spike in yields and increasing illiquidity following poor trading volumes) and large-scale redemptions are their biggest concerns at this juncture.
The prescription
A discerning debt fund investor needs to explore a two-pronged strategy in order to make the best out of these circumstances. Let me spell them out in brief.
- Rationalise exposure to credit risk funds by making tactical withdrawals, assuming that the overall impact of such a move does not add to one’s tax burden
- Allocate more to less risky alternatives, especially liquid and low duration funds, keeping in mind one’s short-term compulsions.
Why do I suggest the use of tax-efficient withdrawals and smart allocations? The reasons are not too far to seek. Simply put, the blighted scenario is expected to stretch for a longish period. In other words, debt market conditions will remain bleak for at least a few more quarters.
In fact, green shoots are not visible at all at this juncture. At the same time, however, I sense a shift in favour of fixed-return instruments such as deposits. An influential section of the investing populace is currently weighing well-rated corporate deposits yet again.
Specific suggestions
Here’s a ready reckoner for the ordinary investor.
- Keep an eye on funds that have serious exposure to securities rated AA and below. The corporate bond space is marked by some obvious lacunae. Such instruments may provide superior accrual but they usually come packed with a farrago of risks.
- Always take into consideration macro factors such as the investment style of the asset management company and its approach towards fund management. Weigh the possibility of investing only when you are satisfied with its credit selection process.
- Also ascertain whether the fund house concerned has in the past come across delays or defaults in any of its credit products. If it has, take it as your red flag.
- Find out whether the fund has regularly resorted to borrowings to cope with redemptions. Any failure to repay such borrowings (by selling securities held by it) will imperil its chances further.
- Strictly avoid over-concentration, an idea that can take several forms in the practical world. A fund that has too many institutional investors among its unit holders is probably not good for you. A select set of big players accounting for an overwhelming share of the assets? No, that is best avoided if you are a small participant yourself.
- Monitor all related developments, particularly those initiated by regulatory action. Remember, the central bank has already opened a Rs 50,000-crore special liquidity window for fund houses. It has further pointed out that tailwinds are likely to be generated on the back of its LTRO (long term repo operations) proposal.
The last bit
As an investor keen on risk-adjusted returns from the debt market, you probably swear by the infallible triumvirate — safety, liquidity and growth. You must, therefore, identify funds that try to offer all three. Yet at the same time you must ascertain whether your fund manager has actually demonstrated what is often sweepingly billed as “credit discipline”.
In the days ahead, the average debt fund investor must be prepared for a set of modest performance statistics. Switching to lower risk products will, quite naturally, lead to more moderate returns. While life will turn rather unglamorous for him, he must still exercise constant vigilance. Any let-up, any failure to recognise palpable market trends, any negligence may result in disaster. For such an investor, I bring another memorable quote from a terribly scary movie. This time it is from A Nightmare On Elm Street: “Whatever You Do, Don’t Fall Asleep”!
The writer is director, Wishlist Capital Advisors