Close to a fourth of debt held by mutual funds now comprises lower-grade paper with aggregate exposure to these having increased over the past year. The share of lower-rated paper in the MF industry’s debt portfolio has jumped from 19% to 23% in the year to February 2016 and is now around `2 lakh crore, data sourced from ICRA shows. In the case of ‘credit opportunities funds’ more than 60% of the corpus is invested in paper rated sub-AAA.
The exposures of a few fund houses — DHFL Pramerica, Franklin Templeton, UTI Mutual Fund and SBI Mutual Fund — at more than 25% remain elevated. For the top 15 asset management companies (AMC) the average allocation to such instruments has moved up from 19% to 26% of the total assets under management (AUM) or from around R10,000 crore to R12,000 crore over the past year. To arrive at the exposure to lower-grade paper, the study excluded top-rated paper — AAA and A1+ — and also sovereign exposure of all the AMCs.
R Sivakumar, head, Fixed Income, Axis Mutual Fund, says the shift does not necessarily reflect the investment strategy of fund managers. “Nevertheless it is true that across industry the allocation towards bonds rated around AA+, AA and AA- has gone up as people have tried to chase higher yields,” Sivakumar concedes.
Industry experts point out that since September last year the focus of fund managers has shifted from longer duration funds to accrual funds. This followed the Reserve Bank of India (RBI) having trimmed the repo by 125 basis points. “The aggregate shift in the AUM towards lower-rated paper is on account of strong inflows into credit funds,” one industry watcher observed.
An analysis by ICICIdirect.com shows that the cumulative corpus of what are called ‘credit opportunities funds’ has increased from R11,900 crore in January 2012 to R63,000 crore in January 2016.
As a significant portion of this inflow was invested in A and AA rated bonds, ostensibly in search of higher yields, the allocation towards sub AAA rated papers has increased from Rs 8,074 crore to Rs 39,828 crore. In other words, 63% of these funds are invested in lower-grade paper.
As Amit Tripathi, Head of Fixed Income with Reliance Mutual Fund, observes credit funds appeal to investors on two counts — higher accrual and lower volatility in returns over the holding period. “We invest in a spectrum of debt which could include lower-rated paper and obviously there is risk,” says Tripathi.
This concentration of money in credit funds, coupled with deteriorating financials of companies, especially from commodity-driven sectors, seem to have caused some trouble in the domestic mutual fund industry this financial year. Among companies that were in trouble and in whom MFs were invested include Amtek Auto and Jindal Steel and Power (JSPL); the debt of both companies was downgraded.
In July 2015, Amtek Auto’s failure to meet its obligation on short-term debt paper led to J P Morgan Asset Management Company (AMC) disallowing redemption in two of its debt schemes and eventually de-merging the Amtek Auto exposure into a “segregated asset” which it is believed to have sold at a loss of15%.
More recently, Franklin Templeton was forced to take a haircut of more than 30% as it liquidated its exposure to JSPL debt in two tranches within ten days just before rating agencies downgraded the Naveen Jindal company to ‘default’.
Post these instances, however, some degree of risk aversion seems to have set in with fund managers now favouring higher rated bonds. “ The downgrade cycle has led increased concern amongst investors and inclination towards higher rated papers has gone up. Sudhir Agrawal fund manager at UTI Asset Management Company says lately he has started investing more in high-grade rather than in lower-grade debt. “Nevertheless, we are still open to exploring names which we think are safe and have no credit risk event,” Agarwal told FE.
Fund managers believe that the lack of liquidity in lower- rated bonds and the absence of optimum diversification in mutual fund schemes have added to risks. “There is no secondary market liquidity for lower rated bonds so if a fund manager’s view changes it could be be very difficult to exit the same,” a fund manager noted. That, he said was the reason for the delay in Franklin Templeton exiting JSPL debt paper even though the credit rating agencies had started downgrading the debt since the beginning of FY16.
Aggregate exposure to lower grade paper has risen over the past year
Share is now 23% compared with 19% in February last year
In ‘credit opportunities funds’ more than 60% of the corpus is invested in paper rated sub-AAA