Mutual Funds: Invested in credit risk funds? Shift to safer banking and PSU funds

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Published: May 27, 2020 12:30 AM

You should evaluate the current portfolio of the fund to understand the extent of holdings in various rating buckets, such as AAA, AA, A rated, etc., and cash holdings.

The sharp markdowns have resulted in heavy redemptions by investors over the past year, with a few funds witnessing signi-ficant erosion in their AUM (>40%).The sharp markdowns have resulted in heavy redemptions by investors over the past year, with a few funds witnessing signi-ficant erosion in their AUM (>40%).

I have invested in one credit risk fund. Should I withdraw the full amount in loss as the NAV is falling?
—Rahul Srivastava
Credit risk relates to the probability of default, or delay in interest or principal repayment by the issuer of a fixed-income security. Credit risk funds are mandated to invest minimum 65% of their assets in lower rated securities (AA and below), which offer higher yields (vis-à-vis government securities and AAA rated papers) to compensate investors for the credit risk involved. Credit risk funds are susceptible to valuation markdowns owing to default / downgrades of the underlying securities, during times of financial stress. The economic slowdown and the current lockdown has resulted in several downgrades and defaults in recent times, with several funds witnessing significant drawdowns (over 25%), and corporate bond spreads widening significantly above their long term averages. The sharp markdowns have resulted in heavy redemptions by investors over the past year, with a few funds witnessing signi-ficant erosion in their AUM (>40%). To meet high redemptions, fund managers are forced to liquidate the higher-rated (safer) instruments, leading to a rise in percentage exposure to lower-rated instruments which are typically illiquid, further escalating the liquidity crunch.

You should evaluate the current portfolio of the fund to understand the extent of holdings in various rating buckets, such as AAA, AA, A rated, etc., and cash holdings. Several fund managers have adopted additional measures to reduce the impact of the prevailing credit scenario on their portfolios such as diver-sifying their holdings across multiple issuers thereby reducing concentration to single issuers, maintaining higher levels of cash to meet liquidity require-ments, etc.

Consult your financial advisor to assess the possibility of further down-grades in the portfolios. AMCs also post regular updates on fund positioning and views on their websites.

Given the current weak economic scenario, allocation to these funds should ideally be capped at 5-10% of the overall portfolio. Evaluate the risk-return trade-off on offer while investing into such funds. Based on your current allocation and portfolio assessment, it maybe advisable to shift to safer debt categories such as banking & PSU funds and corporate bond funds.

The writer is director, Investment Advisory, Morningstar Investment Adviser (India). Send your queries to fepersonalfinance@expressindia.com

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