personal finance

Has credit risk been spread across debt MF categories?


By Dhaval Kapadia and Chintan Mehta

On October 6, 2017, Sebi’s Mutual Fund Advisory Committee (MFAC) announced the re-categorisation and rationalisation of mutual fund schemes. An audacious move with the objective of benefitting the investor, the intent was to pull out duplicate funds of AMCs within a category.

The aim was to bring about uniformity by clubbing funds with similar characteristics into one category. This would ensure that an investor can appropriately evaluate the options before deciding where to invest. Prior to this, standard definitions of mutual fund categories were missing, giving fund houses a free hand when it came to determine a scheme’s characteristics and investment strategy, within a broad framework.

To an extent, the regulation has succeeded in its intent. Unfortunately, there has been an increase in the number of categories within equity and fixed income asset classes. In several instances, the category descriptions/characteristics aren’t clearly defined, providing ample flexibility to fund companies. The result is that most funds have been re-categorised with just a change of name and the fund managers continue to manage them in a similar fashion. This is further substantiated by the fact that the total number of funds merged/ closed from the open-ended funds universe of approximately 860 funds is around 40 funds (less than one per fund house) with an average fund size of Rs 3,000 crore.

CREDIT FUNDS

The regulation has been successful in defining categories by providing a range for Macaulay duration. However, it has fallen short of providing a clear definition of the credit profile or the credit exposure that funds can take for most of the duration categories, including all categories below 1-year duration and several above 1-year duration.

Re-categorisation has further provided flexibility to fund companies for classifying their credit risk-heavy funds in different duration categories. The regulation could’ve clearly defined credit exposure that duration categories can take, which is all the more relevant in a bleak credit environment of defaults and downgrades, where duration funds are not only exposed to interest rate risk but also credit risk.

There are funds across most of the fixed income categories (including those with less than 1-year duration) which carry substantial exposure to sub-AAA rated corporate bond segment. For instance, several funds in the short-duration category have more than 50 per cent exposure to sub-AAA segment, including exposure to single A-rated instruments ranging from 5 per cent to 50 per cent. Of which, few funds have more than 65 per cent exposure to sub-AAA segment and these are not classified as credit risk funds!

One would believe that the intent of creating a credit risk category was to segregate funds taking higher credit risk vis-à-vis other debt funds, thereby allowing investors and advisers to identify such funds in a concise and simple way. Clearly, this purpose has been defeated. Even banking and PSU and corporate bond fund categories have the flexibility of going up to 20 per cent in sub-AAA segment (including AA, A and below rated papers). An investor would, therefore, have no option to select an only AAA-rated corporate bond portfolio.

HYBRID CATEGORY

There are six sub-categories here, some of them with only marginal differences. At first glance, there seems to be a distinction between the Aggressive hybrid and equity savings categories. On further analysis, one can see that aggressive hybrid funds can invest up to 80 per cent in equity, whereas for equity savings, it is 90 per cent, a marginal difference. Further, the uniform scheme description states that equity savings funds could invest in equity, arbitrage and debt. The balanced hybrid category definition clearly states that ‘no arbitrage would be permitted in this scheme/category’ which isn’t mentioned in the definition for aggressive hybrid funds. Does that mean aggressive hybrid funds can invest in arbitrage? And how is it different from the equity savings category? This leaves room for fund companies to employ their own interpretation.

FEWER CATEGORIES

The regulator has taken a step in the right direction as far as standard category definitions go. Although, it would have helped if it had drafted a limited number of categories and meticulously stated characteristics/description.

A stark positive of the categorisation exercise is that fund companies are restricted to only one fund per category. Restricting the number of categories with clearly defined characteristics could’ve had a more significant impact and benefited investors immensely.

(Kapadia is a portfolio specialist and Mehta is a senior investment analyst at Morningstar Investment Advisers India)





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