Which Category Of Debt Funds Remains Intact In The Current Turmoil?

Today, a major concern among debt fund investors is credit defaults.

Typically, investors take additional risks – duration risk and credit risk to generate better than liquid funds returns. When things are in favour, investors generate alpha i.e. above liquid fund returns, and when things are not so good, returns from these funds get affected. If you delve deeper, when duration gets tougher, investors can invest in funds having exposure to low duration bonds. However, when riding gets tough in credit risk, no one knows where to invest.

To simplify things, instead of debating on the credit quality of various fund categories, we will simply look at returns. Clearly, if a fund has suffered a credit event, it will reflect in its returns, considering the impact of mark-to-market valuations and writing down of stressed investments. If a fund category is giving decent returns over the last one year, it means funds in that basket have had a credit-accident-free run. We will look at last one year’s returns as it covers the IL&FS default which broke out in September 2018 and all the subsequent issues.

Let us start with short duration funds, which is the most popular fund category in terms of assets. 27 funds in this category hold papers with maturity bracket of 1 to 3 years. The category has delivered CAGR of 5.1% in one year and 6% in three years. Of these 27 funds, 22% or 6 of them has given negative returns over the last one year.

Let us now look at credit risk funds. The category has been witnessing outflows due to relatively higher credit risk. Over the last one year, a basket of 19 credit risk funds has delivered CAGR returns of 0.83%. These funds have delivered 4.8% CAGR over the last three years. Of the 19 funds, 26% or 5 funds have delivered negative return over last one year. This percentage of negative returns is not much different from that of short duration funds (22% against 26%) but the average one-year return is much different, 5% against less than 1%. The reason is that credit risk funds are deeply in the negative over last the last 1 year.

Corporate bond funds are of relatively better credit quality because as per SEBI norms, minimum 80% has to be invested in highest rated instruments i.e. AAA or AA+. A basket of 17 corporate bond funds has given CAGR return of 4.7% in 1 year and 5.7% in three years. However, there are two negative ticks in this basket over one year i.e. 11.7% of funds in this basket have suffered credit accidents over the last year. Though this category is relatively better than short duration funds in terms of credit accidents (11% against 22%), it has not escaped credit events in spite of maintaining better rated portfolio. Don’t forget, once upon a time, IL&FS and DHFL were rated AAA.

Now comes the safest credit category in a portfolio maturity bracket similar to short duration funds, which is banking and PSU funds. 17 Banking and PSU Fund have delivered CAGR returns of 9.76% in one year and 7.64% in three years. There is not a single negative tick in this basket i.e. funds in this category has remained intact despite credit turmoil. Though there is no defined minimum credit rating for exposures in this category, as per SEBI rules, mostly AMCs buy best credit quality instruments in these funds. Moreover, by nature, banks and PSUs are a better credit risk than companies in other sectors are.

To conclude, going by the experience of last one year, investors can look at banking and PSU funds. However, before taking exposure to such funds, you should look at the portfolio quality.

Source: https://cafemutual.com/news/guestcolumn/393-which-category-of-debt-funds-remains-intact-in-the-current-turmoil

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