In a bid to restore investor confidence on debt funds’ capability to generate return on capital, market regulator Securities and Exchange Board of India (SEBI) has recently sent a circular to all Mutual Funds (MFs), Asset Management Companies (AMCs), Trustee Companies/ Board of Trustees of Mutual Funds and Association of Mutual Funds in India (AMFI) containing guidelines to amend investment norms for MFs on investment in Debt and Money Market Instruments.
The new guidelines bar MFs from investing in unlisted debt instruments, with some exceptions, which are used by mutual funds for hedging. However, conditional investments in unlisted Non-Convertible Debentures (NCDs) not exceeding 10 per cent of the debt portfolio of the scheme are allowed.
To ensure further diversification, SEBI has made capping on investment limits on debt instruments more stringent and has also lowered the cap on sector exposure limit from 25 per cent to 20 per cent.
Experts hope that the new and stringent guidelines would help debt funds manage risks better, as the effects of failures of bonds and other debt instruments on the funds will be low.
Arun Kumar, Head of Research at FundsIndia.com, said, “These guidelines will help to enhance risk management in debt mutual funds and improve investor confidence. One of the key highlights, is that mutual funds won’t be allowed to invest in unlisted instruments which includes unlisted Commercial Papers (CPs).”
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Raghvendra Nath, Managing Director of Ladderup, also thinks one of the biggest takeaways from this circular is that mutual funds will not be able to invest in commercial paper which is unlisted. “Over exposure to CPs both for lenders and borrowers was a major source for a number of issues in the recent debt crisis,” he said.
“The requirement for investment in listed CPs will enhance disclosures but this is more an operational change. Many CP issuers were already issuing listed NCDs. It is hard to see why any borrower would come to a mutual fund now for this type of lending when banks can offer easier terms,” added Nath.
“These guidelines will enhance risk management, help in diversifying portfolios and improve investor confidence in debt funds. It will improve fund managers discipline and help them in limiting their exposures to a particular Sector or Group. However Returns on debt funds are always linked to market, liquidity and credit risks, but given the episodes of the last one year, I believe that this trend towards flight to safety will continue for some more time,” Nath further said.