Transfer Of Less-Liquid Debt Between Mutual Fund Schemes Sparks Some Concern

After Franklin Templeton Asset Management (India) Pvt. Ltd.’s shock decision to freeze six schemes, investors and financial planners have flagged a spike in less-liquid bond holdings of hybrid schemes of top asset managers.

In a letter to BloombergQuint last week, an investor pointed to several transfers of non-convertible debentures between schemes of ICICI Prudential Mutual Fund. According to data on the asset manager’s website, these bonds rated ‘AA’ and below were moved from its Credit Risk Fund to the Balanced Advantage Fund, and Equity and Debt Fund between April 27 and April 30.

It’s a legal way of transferring securities from one scheme to another within the same fund house. These are based on a valuation by an independent organisation.

But the investor, who wished to remain unnamed to share details candidly, said he opted for the Balanced Advantage Fund as he didn’t want to take on the risk of a completely equity-oriented portfolio. The debt portion of the hybrid scheme, he understood, was meant to act as a hedge in times of extreme volatility the stock market. The addition of bonds rated AA and below was making him take on more risk than he wanted, he said.

Other asset managers, too, have made similar debt transfers between schemes.

That came after Franklin Templeton Mutual Fund wound up six credit schemes with similar lower-rated bonds citing liquidity issues and redemption pressure. While “AA” rating is a couple of notches below the highest “AAA”, it’s above the lowest investment grade of “BBB”. But the number of buyers of such debt has dwindled since the Covid-19 pandemic froze economic activity.

“One can see that the liquidity of corporate bonds rated AA and below is very low by the elevated yields that are being quoted for such trades,” said Ajay Manglunia, managing director at JM Financial. “The risk aversion has caused a drop in appetite for these papers and, as a result, the spreads have widened substantially.”

ICICI Prudential Mutual Fund and HDFC Mutual Fund saw the most dramatic shift in the composition of the debt portfolios of their hybrid schemes, according to a BloombergQuint analysis of mutual fund portfolios with highest redemption in credit risk schemes. While other asset managers also conducted inter-scheme transfers, these did not result in a material change in the composition of their debt portfolios, as of April-end.

The share of non-convertible debentures rated AA and below in ICICI Prudential’s Balanced Advantage Fund more than doubled in a month—from 5.6 percent of the net asset in March to 11.5 percent in April, according to data available on the asset manager’s website.

For ICICI Prudential’s Equity and Debt Fund, that went up from 8 percent in March to 13.4 percent in April.

In the Hybrid Equity Fund of HDFC Mutual Fund, the quantum of non convertible debentures rated AA and below jumped 361.9 percent month-on-month to Rs 868 crore in April, according to its disclosures. At the end of April, these accounted for 5.3 percent of the scheme’s NAV compared with 1.3 percent a month earlier.

According to data reviewed by BloombergQuint, bulk of the additions came through transfer of debt from the credit risk funds of the two asset managers.

DSP Mutual Fund in April transferred Rs 146.28 crore worth of bonds of Green Infra Wind Energy Ltd., rated AA by Crisil, from its Credit Risk Fund to its Equity and Bond Fund. They account for 2.6 percent of the NAV of the Equity and Bond Fund.

What Fund Houses Say

In response to a query from BloombergQuint, ICICI Prudential Mutual Fund said the addition of the debt to hybrid schemes was strategic.

“The Balanced Advantage Fund (BAF) actively manages its equity exposure levels between 30 and 80 percent based on an in-house model which majorly considers market valuations. The remaining allocation is invested into equity arbitrage opportunities and debt instruments,” the asset manager said in an emailed response.

Based on this model, the fund house said:

BAF increased its equity level from 45 percent as on Dec. 31, 2019 to as high as 74 percent as on March 31, 2020.
Post the rally, BAF decreased its net equity level to 67 percent as on April 30, 2020.
The decrease in net equity level from 74 percent to 67 percent during April 2020 essentially required an increase in debt allocation of the fund.

A significant proportion of the reduction in the net equity level of the scheme happened in the last week of April when equity benchmarks rose by 6 percent, according to ICICI Prudential Mutual Fund. During this time, yields on debt securities increased sharply due to the strain on availability of liquidity for corporate bonds, it said.

“BAF had bought the debt securities from various market participants including banks, mutual funds considering the attractive valuations that were available,” the fund house said. All investment decisions, including those in debt securities, are undertaken based on a risk-reward assessment, it said.

A spokesperson for DSP Mutual Fund said that bids were available in the market for the bonds and the asset manager could have opted to either sell the paper or move it to another scheme. It opted for an inter-scheme transfer because of the “favourable credit outlook” on the bonds.

“Please note that the inter-scheme transfers are done for bonds where destination fund reflects a similar appetite for credit,” the spokesperson said. The transfer took place because the Equity and Bond Fund has exposure to bonds rated up to AA, the company said.

HDFC Mutual Fund has yet to respond to emailed queries.

Other mutual fund scheme portfolios BloombergQuint analysed didn’t see a material change in composition.

Higher Risk Not Warranted: Financial Adviser

The purpose of equity-oriented hybrid schemes, according to Kirtan Shah, chief financial planner at Sykes & Ray Equities, is to provide investors a hedge in difficult times.

“If I’m getting someone to invest in a hybrid fund, I’m assuming that the individual’s risk profile is slightly lower than 100 percent equity fund,” said Shah. “If they’re going to take equivalent risk in debt, then for me the debt component and equity component put together becomes something like 100 percent equity. It doesn’t really solve the problem for which hybrid funds are meant.”

While a higher proportion of lower-rated and higher-yield debt could generate better returns for these hybrid schemes, they are doing so by taking higher risk.

“But again, if they’ve done it (inter scheme transfers) because they wanted liquidity in the credit risk fund, then that is not the right strategy and definitely, they shouldn’t have done it,” said Shah. “Because the thought is very simple and straightforward – when I’m investing in hybrid, equity is for alpha, debt is for capital protection. But if you are going to increase risk in debt, then I might as well take exposure to 100 percent equity funds.”

With big redemptions from credit risk funds in May, the composition of the debt portfolios of hybrid schemes could change further.

“Maybe the April numbers are too small to warrant a review of investment into hybrid schemes. I think the larger impact could be seen in May,” Shah said. “If in May the numbers go up drastically, we’ll definitely reconsider the situation.”