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#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

Market regulator SEBI’s directive to Indian asset managers to classify their debt funds under 16 new categories will benefit investors by bringing uniformity in the categorisation of schemes.

That’s the word from Rajesh Iyer, chief executive officer at DHFL Pramerica Asset Management Company and Kaustubh Belapurkar, Director of Fund Research at Morningstar Investment Adviser India Pvt. Ltd. on BloombergQuint’s weekly series, The Mutual Fund Show.

The Securities and Exchange Board of India in April this year directed mutual fund houses to re-categorise all their schemes in the new and distinct categories specified by the regulator. In the debt space there are 16 new categories under which fund houses must align existing and new schemes.

Investors will benefit from this move which requires all mutual funds to have same categories, said Iyer said. The other advantage with the categorisation is investors’ expectations will be set right as they will be able to differentiate apples from oranges and invest based on their risk-return profile, Belapurkar added.

Watch the full conversation here:

Does it simplify things or make it slightly more complicated now that there are 16 categories?

Rajesh: One big thing which has happened to all investors is all the categories are similar for all the mutual funds. It is very important when you make a decision to assess in terms of performance. Earlier it used to be very difficult and now it is simplified. That is one big step.

Kaustubh: Setting the expectation right from an investor’s perspective - when he is getting into the category, he knows what it is designed to do. So, from his risk return profile he can match what he needs from a category. Earlier it was more open ended. He didn’t know..there could be diverse funds within a particular category. Now there is a pretty close bucket that’s been created. So, he knows what he is getting into.

What is an overnight fund?

Kaustubh: This category is more relevant from an institutional and corporate investor’s point of view where they are looking for short term or literally overnight as the name suggests. Not so much for retail investor. He will not be bothered about parking money away for a day. This is probably the safest category, when we look at the risks - either interest rate risk or the credit risk, this could be low on both criteria. It is almost close to negligible.

#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

Rajesh: It is just for the institutional investor. Retail doesn’t need to bother about it. It is a very important step for the institutional investor. We all remember the liquidity crisis when people wanted to get out and there was a huge issue. I think SEBI has rightfully addressed it.

What is a liquid fund? What kind of investors should think about investing in a liquid fund?

Rajesh: It’s for risk averse or secure investors who will park the money for something that they want to do in life. So, this would be for that kind of investor. Institutional money is quite prevalent in these segments but even high net-worth individuals and retail can participate if they want to park the funds.

#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

What kind of return can people expect in a liquid fund? Do the returns materially differ from some of the others?

Kaustubh: It is largely for corporate investors. But if you have very short-term requirements, like you got a bonus or want to deploy in the market, then you can get into liquid funds for a very short term. It could be for a couple of days or weeks or months. That is traditionally what the retail investor will do it. It is hard to pin down numbers. Since there is very little risk with this product the returns will be lower than some of the other categories.

So, better than keeping your money in a savings account?

Kaustubh: I would say may be little bit of a tradeoff. It gets operationally easier to do it through a liquid fund when you want to invest through the markets, especially the SIP route. It will be marginally better than best. There is obviously an element of taxation. But this is marginally better.

Does the ultra short-term fund differ from this? What is the nature of the fund?

Rajesh: If one has an investment horizon of 2-3 months roughly, then it makes sense for those investors because you get a little higher carry. It will be somewhere in the ballpark of whatever you make in liquid funds. The target is to make 50 basis points higher compared to liquid funds.

#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

Would you think that somebody parking in liquid funds should think of a time horizon of 1-2 months. Beyond two months may be the ultra-short-term duration fund is a better option?

Rajesh: For 2-3 months, if the money can stay. I think it is a good investment.

Kaustubh: Investors should look at the time horizon. With each bucket that is there on the duration side, you can match the amount of money you want to keep in it. So, liquid funds for short term and for ultra-short term, over three months will be the ideal time horizon where you want to earn that carry over liquid funds, which carries no interest rate risk.

This will carry a very marginal return but higher than a liquid fund. But if you have that time horizon you are fine because you are meeting the time horizon with the maturity of a fund.

What is the difference between ultra-short duration fund and the next category which is a low-duration fund?

Kaustubh: Low duration will take a slightly higher duration of exposure. It goes up to 6-12 months. So, the interest rate risk will be slightly higher. If you are expecting your yield curve to be a regular steep yield curve sloping upwards, you could get a higher carry for instruments that are slightly longer term.

As the tenor goes up, the interest rates risk will increase. That means the price of the bond could fluctuate in between depending on the yield movements. As the tenor increases, the interest rate risk increases. But as long as you match the profile, if you are getting into a fund which is typically in that 6-12-month band, you should be reasonably okay because the instruments will be maturing, and your interest rates risk would be dampened at that period.

#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

Would you agree that people investing in low duration fund at your house would be investing with a time horizon of 6-12 months in mind?

Rajesh: In low duration fund, there will be little bit of credit also added, compared to the other categories. You will have a little bit of credit also tossed in. So, it is not just the duration where you are going high. It is not that it is as bad as the other categories, but this will be just an introduction to the credit. The alpha that you can expect from a liquid - we were talking about ultra-short to liquid was 50 basis points and hwre you can expect 75 basis points. You are taking a little bit of credit risk and little bit of more duration.

What is the money market fund?

Rajesh: These investment papers which technically means that the investment value, say, is 90 and it expires at the end of one year at 100. So, it is no bonds, just the money market. Not much difference but it is little bit more liquid.

#BQMutualFundShow: New Debt Mutual Fund Categories Simplified

Is the time horizon for someone who wants to invest in a money market fund different from previous categories?

Rajesh: This will be a little lower in terms of credit risk because this only talks about money market, to that extent, and better liquidity. That’s the only difference.

Kaustubh: The time horizon is up to 2 years and not more than that. These are typically the most liquid instruments and we’ll get into elements where liquidity does matter in some of the other categories. These are instruments which are fairly liquid, well priced and your risks are well contained.

Rajesh: If you look at low duration money market fund, if a person would like to go a little longer than 6-12 months, but doesn’t want credit risk tossed like in terms of low duration fund, so he goes for a money market and is much more comfortable earning that, a little bit more by not taking the credit risk.

Let’s say someone has got a bonus and wants to utilise this money 2-3 months out, what are the options?

Kaustubh: Liquid fund predominantly, ultra-short comes in a couple of months. If you have a couple of months, then get into ultra-short duration fund.

If he wants to utilise the money six months out, what kind of options should he go for?

Rajesh: Low duration stroke money market depending upon his appetite for credit risk. So, if credit risk is a no-no then he can go for money market.He can tolerate a little bit of credit risk, then he should go for low duration.