Though the mutual fund schemes investing in the low rated bonds appear to be a risky space, experts are divided about the investment worthiness of these schemes.
One man’s meat is another man’s poison. But in the case of debt funds, it could well be the other way around. The net asset values (NAV) of many debt funds have fallen dramatically in the past 7-8 months, ever since the Infrastructure & Leasing Financial Services Ltd crisis broke out. In the middle of all this turmoil, could there be an opportunity?
Delayed interest payments and principal repayments, defaults, credit rating downgraded that have led to a fall in NAVs; bond funds have been in the news for all the wrong reasons. Some of them have also stopped taking fresh subscriptions. Finally, last week, the capital market regulator, Securities Exchange Board of India (SEBI) came up with a slew of measures to de-risk debt funds, especially liquid funds, some of which have been caught with toxic instruments.
While the fall in NAVs of some of these schemes speak about the nasty past, the lessons learnt in the current crisis may help the fund managers make more informed decisions in the light of new regulatory guidance.
But the question is this: As NAVs across many debt funds, holding low credit-rated bonds have fallen, is it a good time to invest in such bond funds? The idea is to profit from them as and when these funds make their recoveries from their bad holdings. Or is it just better to stick to relatively safer options?
Opportunity amid landmines
There are a few schemes which have seen a steep fall in NAV either because of default or because of haircuts; an automatic fall in the NAV as a result of re-valuation of bonds on the back of credit rating downgraded. For example, BOI AXA Credit Risk Fund and Tata Corporate Bond Opportunities Fund lost 46% and 40% respectively over past one year. There are many other schemes that have lost up to 6% over past one year. The idea is to buy into these portfolios now and then benefit from the sharp upward move if the underlying company (in which these debt funds have invested in) pays up on the due date or the fund house manages to recover money from them. <See table>
Though it sounds tempting, it’s not as easy as it looks. Firstly, not all such schemes have been accepting fresh money. Fund houses such as Edelweiss Asset Management and BNP Paribas Asset Management (India) have decided not to accept fresh investments in their affected schemes. Therefore, there’s not much you can do here.
For all other schemes where you can invest, things aren’t so rosy. “If you invest now in one such scheme that has seen losses in the past on account of default and the underlying company pays up, then you will make some money. But, what if you invest in a scheme and the redemptions continue?” asks Joydeep Sen, founder of wiseinvestor.in. In such a case the fund manager will be forced to sell his good investments (in addition to other good scrips that the fund would have already by now, to meet its redemptions since crisis time) and the portfolio will be saddled with the bad papers. Put straight, this is a risky proposition for investors in bond funds. “If at all you want to consider such an investment, you should only look at large diversified funds with large asset management companies,” adds Sen. He is of the opinion that credit risk is difficult to measure, especially for naïve investors and such investors should steer clear of such adventures.
Experts say that since bad asset resolution usually takes time, it may not be worth your wait. “You have to invest on case to case basis. Each portfolio need to be assessed and one should check if there is a scope for recovery,” says Feroze Azeez, deputy chief executive officer, Anand Rathi Private Wealth Management. He further advises staying away from the schemes that are running concentrated portfolios. He is not alone.
Harsh Jain, COO of Groww, a mutual fund investment portal said, “Funds with concentrated bond portfolios are high risk investments”. For example, DHFL Pramerica Short Maturity Fund has only five securities issued by four issuers in its portfolio dated May 31, 2019. In last one year it held 37 securities at its peak. Frequent redemptions on the back of default crisis has left the scheme with its bare bones. Typically, short duration funds hold around 55 securities in their portfolios, as per Value Research, a mutual fund tracking portal.
One way out is to invest in side-pocketed units. However, there is not much clarity on the same at this juncture. As per the SEBI circular on segregated portfolios (side pocketing), the side pocketed units need to be listed on the stock exchanges to provide exit route to investors. There is a fair chance that these units may quote at a steep discount, if and when listed. If you can estimate the possibility of recovery of money and the extent of recovery, then you can take a calculated call. But there is a fair chance that the original investors may want to wait it out instead of selling them at steep discount.
However, there aren’t many side-pocketed units out there, at the moment. Tata Asset Management is the first mutual fund to announce side-pocketing in the current regime. Hence one may find it difficult to predict how it will work out. Also a point to note is that the units of closed-ended funds that are listed on the stock exchange rarely trade and one seldom gets to trade near fair value of units. In other words, you’d most probably be called to hold on to these units- if you ever buy some of these- till maturity (the time when these funds recover their dues from the defaulting company; investors of side-pocketed units are then paid off and units get extinguished).
Light at the tunnel
Though the mutual fund schemes investing in the low rated bonds appear to be a risky space, experts are divided about the investment worthiness of these schemes. “We have seen defaults and write downs in many bond funds. The portfolios reflect the true value of the underlying (assets) and the yields are really attractive,” says Abhinav Angirish, founder and CEO of investonline.in, an online mutual fund distribution portal. He recommends investing in credit risk funds only if you have 3 to 4 year time-frame.
But does it mean that you should avoid credit risk funds? Azeez prefers to build a diversified basket of credit risk funds. His approach is calculated. He recommends investing an equal amount of money in a portfolio of seven credit risk schemes that he has shortlisted for his clients. Azeez tells us that the idea is to get exposure to 157 unique companies (through his curated list of seven such schemes) and only 10 of these companies hold more than 2 per cent of these schemes’ corpuses, individually. “The idea is to reduce the risk. The damage to the portfolio should be minimal if an issuer goes belly up”, he adds.
However this approach entails high risk. Only if you can stomach high volatility should you even think about walking down this path. Roopali Prabhu, director and head of investment products, Sanctum Wealth Management sees pain ahead. “We see credit risk intensifying in near future. There is a tendency of risk aversion and the credit risk as a category cannot be recommended at this juncture. However, extreme market reactions may throw up some opportunities that offer disproportionate return in relation to risk, where tactical allocation makes sense”, she says.
For most of us, we are not used to seeing such wild swings in our bond funds. Many investors have still not recovered from the shock of their funds falling by more than 30% in just one day. The investors need to factor in high risks associated with the high yield portfolios. “It is the time to avoid chasing high yields. Investors should be better of investing in mutual fund portfolios investing in good quality paper to keep the volatility low,” says Jain of Groww.
Prabhu agrees. “It is better to invest in short term funds investing in short term quality papers,” she says. She recommends investing in Banking & PSU Bond fund as well.
Although there could be a few opportunities here and there, this is a risky path that is laden with landmines. And even if you manage to navigate them all, the end result may not be worth it if your fund still is unable to recover its dues in time.