Debt funds have hit a rough patch lately and their net asset values have seen some depreciation. Many of you who have debt funds in your portfolio may be wondering whether you should still remain invested in these schemes. Others, who have heard that debt funds are less risky than equity funds, may be thinking debt funds are best avoided.
There's, however, no reason to panic. This is not the first time that mutual funds have been through a crisis. The current crisis is largely confined to defaults among non-banking finance companies and within that not all have been affected. Debt funds still continue to give better returns compared to fixed deposits and are more tax-efficient. Big debt funds have a widely diversified portfolio and that provides some comfort.
Defaults among NBFCs
Before we get into the merits of investing in debt funds, let us go to the root of the problem, that is the debt segment itself. It started in September 2018 when Infrastructure Leasing & Financial Services defaulted in making repayments on debt instruments issued by it. This led to a downgrade in its credit ratings. Subsequently other companies such as Dewan Housing, Essel Group, Anil Ambani group companies started defaulting on their debt repayments. Debt mutual funds, as you know, invest in debt issued by corporates and since many of them had invested in the debt securities of the companies mentioned above, the value of their investments fell. They had to make provisions for it as well. Mutual funds also lend money to promoters against shares as collateral and with share prices of the defaulting companies plunging this resulted in losses for them.
The problem only seems to be rising because more companies are defaulting on their debt repayments now. Mutual funds values have also been hit because there has been a rush for redemptions by investors. In FY19, investors redeemed Rs 1.25 trillion worth units compared to just Rs 91.3 billion in FY18.
Do your due diligence
First, you need to assess whether the funds that you have invested in have given good returns in the past and what has been their track record, the AMC behind the fund, etc. While past performance is no guarantee for future returns, if over the last 5 to 10 years the scheme has given returns that beat the benchmark most of the time, then there is no reason for you to worry and we would recommend that you stay put.
Despite all the defaults, there are still healthy companies out there. Look at the debt portfolios of the schemes where you plan to invest and if their rating is AAA (or anything equivalent), you can go ahead and invest in these schemes. Do not invest in schemes where the debt rating is below that, at least for the time being. You need to check every scheme's portfolio periodically to ascertain that the investments are healthy.
Invest in liquid funds
You can also turn to short term or liquid funds. For instance, schemes investing in government securities are performing as usual and so are funds investing in money market instruments.
The current upheaval in the market regarding debt funds is not due to the fault of the mutual funds but the companies in which they have invested. The fund houses had no warning of what was to happen as almost everyone was taken by surprise by the events.
Fund houses are doing damage control of their own. They are ring-fencing their bad investments from the good portion of their portfolio. What this means is that the debt portion that has lost value has been put into separate schemes so that the value of the main portfolio does not suffer. Another strategy they have adopted is to merge unviable schemes with debt exposure to doubtful assets with larger healthier ones. This brings down the proportion of bad debts as a percentage of the total assets in the portfolio.
Remember that debt funds are exposed to both credit risk and interest rate risk. At the moment credit risk is dominating because a few companies that issued the debt are struggling with cash flows. Just as it is important not to be swept away on a euphoria, it is important not to succumb to a downturn. Every sector, every business passes through a cycle. So stay put, invest sensibly, do not panic, do your due diligence and ride out the current trouble and you should be fine.
(By Harsh Jain, Co-founder & COO, Groww)