September 6, 2019

Yeh sab kya ho raha hai? : Debt mutual funds

Lakshmi Iyer

Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company (KMAMC)

Yeh sab kya ho raha hai? : Debt mutual

  3 idio(synchracies) in bond markets

Behati Hawa Sa Tha Woh….Kahaan Gaya Use Dhundon…. This is a song from the movie 3 Idiots… why am I starting with this song? Because this is the mood being characterised by the investor when it comes to investing in debt funds! – Specifically credit funds.

Let’s get into a flashback mode and see where and how this actually emanated. It all started around the same time last year when IL&FS (rated AAA) defaulted. For AAA credit to default is quite blasphemous, at least in the financial world. If that jolt wasn’t enough, what ensued post that was a series of delays and defaults – including that of more AAA rated credits !! Suddenly what was being revered as gold standard, fell in worth to a basic metal which is highly rust prone. Investors started getting panic attacks and most of them actually morphed to fund managers. Little did they realize that diversification in mutual funds is the first principle which offers a cushion in such market conditions – i.e. Zorka Jhakta..Dheere se….

If one looks at the MF portfolio spectrum, there is a heavy skew towards high grade credits with tail ended allocations to moderate risk credit assets. There is a category within debt MFs which cater to lower down the credit spectrum which is aptly titled as ‘Credit Risk Funds’.  Most categories apart from this, tend to invest in high grade corporate bonds apart from sovereign assets. Also, this category is much smaller in the entire AUM for debt mutual funds (less than 10 % of the total debt Mf AUM). However, if managed well, this category has the potential to channelize retail money from traditional mode of investments, and also offer potential for participating in market upside.

Lately we have seen crises of confidence with respect to the credit fund category. The once favored fund category has now become a pariah. Recency bias seems to be playing on the investors’ and advisors’ mind. This is quite typical behavior displayed across asset classes. Even Gold ETFs were not spared at a time when gold prices were headed southward (outflow still continues!).

It is very imperative for an investor to make allocations to an asset class only once he/she has fully understood the pros and cons. In case of fixed income investments there are many assumptions investors make. Among them, the 3 Key idiosyncratic mindsets worth highlighting are as follows

• Fixed income means fixed returns – the only thing fixed about fixed about fixed income is its unfixed nature! Often, there is a tendency to assume that fixed income funds offer fixed returns. Fact is that fixed income investments tend to deliver returns in line with interest rate movements. Unless one buys a fixed income instrument and holds it to maturity, the investments will be subject to vagaries of interest rate fluctuations
• Every downgrade means default – this is so very relevant in the current market scenario. There was a time when issuers were considered AAA plus plus (such rating never existed) and now is the scenario when some issuers are considered D minus! (Yet another extreme reaction to recent events). One needs to understand clearly that upgrades and downgrades are a function of the business cycle and the overall macro economic scenario that is prevalent at the time of the rating action. One needs to clearly understand that every lump in the body need not be malignant!
• Higher the YTM, higher the returns– the more you infuse sugar syrup into a rasgulla, the tastier it gets… Great taste need not necessarily mean good for health. Likewise, higher Yield to Maturity (YTM) could also mean greater proportion of lower grade instruments in the portfolio. Hence it always helps to do a portfolio check than just being carried away by the optics in a portfolio

Lastly, one cannot undermine the role of advisory is such volatile times. Be it Sachin Tendulkar or PV Sindhu – how every acclaimed they were in their respective sport, they did benefit from the guidance of the coaches in their respective field. Advisors play the vital link between the manufacturer and the investor – a bridge that is built on a strong foundation of trust. Ultimately patience pays. Irrespective of the asset class, it is important to maintain the discipline of asset allocation – which is easier said than done. Greed and fear are the two key emotions which investors need to conquer while making investment related decisions. Lage Raho..Investor dear….