The Mutual Fund Show: What Next For Debt Fund Investors After Franklin Templeton Fiasco?
When Franklin Templeton Mutual Fund closed six yield-oriented, managed credit funds last month, citing “severe market dislocation and illiquidity” caused by the Covid-19 pandemic, it resulted in outflows from credit risk schemes.
The crisis may be a good time for retail investors to do a “check-up” of their portfolios and take corrective actions if necessary, according to Dhawan Dalal, chief investment officer of fixed income at Edelweiss Mutual Fund.
In this week’s The Mutual Fund Show, Amit Bivalkar, director at Sapient Wealth Advisors & Brokers Pvt. Ltd., also suggested a checklist for retail investors to examine before they consider debt mutual funds.
- Credit profile of the fund: Monitor if portfolio has securities rated below AA+ in excess of 20 percent.
- Maturity/duration: Ensure fund maturity matches cash flow personal requirements.
- Percentage allocation to each security: Not more than 3-4 percent of portfolio should be invested into a particular security.
- Dividing investment into various categories: Should be based on liquidity, predictability, returns and volatility.
Dhawan also said retail investors must look at the groups or business houses that these funds are investing as that helps them understand the group's solvency, credit and finance parameters.
Both the advisors urged investors to not to panic but be more vigilant while choosing select fund categories.
Watch the full conversation here:
The Franklin Templeton episode was not necessarily just a credit quality risk; it was probably a liquidity risk that led Franklin to do this. How should an investor read into this?
Dalal: Absolutely correct. This is not a credit crisis; it’s a liquidity and solvency crisis. So in that regards, it is important to understand that retail investors do not understand these issues inside out. That is exactly why at this point of time; the role of distributors and independent financial advisors becomes very important. I think, just like we normally go for our annual health check-up, is very important that individual investors should also do an annual check-up of their portfolios in order to find out if everything is alright with that portfolio, because as you know that the financial markets are extremely volatile, situation keeps changing, economies are in doldrums, and as you know credit funds are directly linked with the performance of the economy as well as with financial markets, particularly equity markets.
So yes, it is important that we do a periodic check-up of our portfolios and take appropriate decisions on a timely basis.
One such episode and there has already been a fair degree of outflows from credit risk funds. What are you advising your clients in such a scenario?
Bivalkar: One important thing to think about is that bond investing is negative art of investing, and what it means clearly is if you have 10 bonds which are giving 8 percent each, it is which bonds you don’t buy actually in your portfolio. That’s why I said negative art of investing.
What is more critical is that not that all credit funds are bad. It’s just that probably the timing right now in the Covid-19 pandemic is such that as Dhawan pointed out, economy is in doldrums and there is no liquidity in the bond market, and therefore you are seeing such kind of redemption. I think this is more of a panic created rather than panic which has happened. I don’t think that as an investor community, one should take this call, because then you are throwing in the towel, and probably this category might be the best performing category over the next three years, you never know.
I think liquidity, volatility, predictability and returns--that is how you should look at while choosing a fund, and I think that is what is critical.
In case of Sapient, we have been conservative on the credit side. We had advised clients to move out long ago. Have some clients who have exposure in the low duration short term category where I don’t think so you need to panic or you need to throw in the towel just now. I think things will settle over the next one or two months, and even a five-year return on a credit risk fund after such a debacle is at 7 percent. A low duration is at 8 percent and ultra-short term fitting is at 6 and a half, 7 percent. So I think so you need to wait it out rather than take that call. It’s the fear that I will be the last man standing, that is actually driving out investors. The important job here is of the advisor and the media to actually give that calmness to the market by saying that this has happened to one particular fund. It should not translate into others.Same like PMC Bank had everyone withdrawn the deposits from cooperative banks, imagine what would have happened to that sector. I think we need to limit it to that particular fund and those schemes. I think that is what I will advise to people.
Some experts point out that credit risk funds are not necessarily well suited for retail investors because a lot of times a retail investor doesn’t know what kind of fund they are getting into. He or she believes that the credit risk fund is like any other mutual fund, it is low risk and it will give you a better return than a bank fixed deposit.
Dalal: Absolutely, as you rightly pointed out, retail investors generally do not have finer understandings of what the credit funds are all about. Where do they invest, what kind of liquidity do they have etc? I think most of the decisions are taken based on the past performance, advice of the investors, as well as advice of the other friends or relatives who have invested in this kind of funds and have decent returns. The fact of the matter is that you push the trigger and the money comes into your account next day. So these are some of the convenience and other factors which have driven enormous amount of inflows into credit funds over the last couple of years.
In fact, the genesis of the credit fund if you go back, actually was after the global financial crisis when the normal AAA rated bonds were giving returns as low as between 5 to 6 percent. That’s when the credit funds came into vogue because they were giving about 9 to 10 percent returns.
Now, I think it is important to know from an investor’s perspective that the credit funds are interestingly linked to the performance of the economy, and we have been observing that over the last 12 to 15 months, credit funds have been losing money month after month, and that was partly linked to their performance.
Credit funds started losing that sheen of the additional 2 to 3 percent returns, a long time ago.
Right now, as Amit pointed out that the performance of credit funds on aggregate is at par with some of the AAA-rated bonds, or even below liquid funds. So the combination of performance, concerns on liquidity, as well as some of the downgrades and defaults that have happened over the last couple of months, particularly after IL&FS and DHFL episodes, has got clients to sit up and take note of what’s happening to their portfolio and take corrective actions.
At Edelweiss AMC, as the CIO, what are the safeguards that you deploy? In the last 24 months, has any debt scheme, not just a credit risk scheme, faced an issue like this?
Dalal: That’s a good question. But before I answer the question, let me tell you that the six schemes that were so called under the managed credit solutions of Franklin Templeton, I think it is important to note that despite SEBI categorization on funds, I think most of the schemes, had relatively higher exposure to so called high yield or risky credits as compared to the rest of the industry. So, in a nutshell Franklin Templeton didn’t have one credit risk fund which is what is allowed under the SEBI categorization, but it could perhaps be fair to say that six schemes were running as a credit fund or a quasi-credit fund. That I think has gotten into trouble for investors.
As far as experience of Edelweiss Asset Management is concerned – yes, we got hit because of our exposure to DHFL, but we are working at resolving that. But the lesson that we learnt since the DHFL episode, is that we have tightened our credit standards significantly.
Now we are poring over the legal documents, and term sheets much more carefully in order to understand what kind of risks that we are getting into before we invest. So that’s a big lesson for us.
In the current scenario, what all should retail investors look at, before investing in debt funds?
Bivalkar: Any debt investment should be looked at from a liquidity risk perspective, interest rate perspective, as well as a credit risk perspective. Obviously there is also a sovereign risk but I don’t think so we should talk about it right now.
But if you look at the liquidity risk perspective, right from your liquid funds, up to your credit risk funds, SEBI has given you a riskometer to see what kind of risks actually exists into that. SEBI has also made categorisation of schemes, wherein you can look at what are the maturities of these schemes over a period of time.
Where are these data points available?
Bivalkar: They are available in the SID, which is the scheme information document of every mutual fund, and also on SEBI circulars.
So broadly, people come into debt because they want a higher post tax return, compared to a fixed deposit. That’s how you’re having more and more retail participation in the 20-30 percent tax bracket. Now, when you look a fixed deposit and mutual fund, clearly what we used to say is that you will get your money back in one day; in partial or at full withdrawal. I think that was the biggest selling point, you have to look at the inherent risks which are there in such kind of categories.
So if you have money which needs to stay for one month, I think you need to come into a liquid fund. If you have money which is going to stay for three months, I think you need to come into ultra-short category. If you have money which is going to stay above three months but below one year, you should come into a low duration category, and at three years, you can go for a banking PSU fund or a corporate bond fund.
You have to actually look what is best suited for you, depending on the liquidity and credit profile of the portfolio. For example, after Covid-19, everybody is talking of a slowdown; everybody is saying there is a problem in NBFCs and banks because NPAs will rise. So, at this juncture, if you want to look at more than three years of investment in a banking PSU or in a corporate bond fund, I think 70-80 percent of your portfolio should be in AAA assets, 20 percent can be in AA+ assets and you will still beat your fixed deposit on a post-tax basis.