Credit risk funds play it safe
Credit risk fund portfolios today seem to convey a sense of security, having changed significantly since the Franklin Templeton episode triggered a net outflow of 19,239 crore (35% of then-AUM). ) of these funds in April 2020.
During the year ended July 2021, exposure to sovereign debt, corporate debt rated AAA and AA / AA + / AA- increased for these funds, while exposure to more debt securities risk A / A + / A- has been reduced (see chart).
Today, there are 17 credit risk fund systems offered by different mutual fund AMCs. These funds are intended to invest in debt securities of relatively lower-rated issuers for higher returns – they must invest at least three-fifths of their net assets in AA and lower-rated debt securities. Another 10 percent must be in liquid assets. The remainder can be invested in papers of any credit quality.
At the top of the quality ladder
ACE MF data shows that seven credit risk funds saw their exposure to AAA-rated corporate debt securities increase during this one-year period. Among those that experienced the largest increase in exposures were the Nippon India CRF and the PGIM India Credit Risk Fund (CRF).
According to Sushil Budhia, Senior Fund Manager, Nippon India MF, the weak base last year after the sale of AAA rated securities to meet redemption requests, and the lower availability of good corporate debt issues in the segment AA and lower at a good price have contributed to this rise.
In addition, 11 of the 17 credit risk schemes had a higher proportion of AA / AA + / AA- corporate debt instruments in their portfolios in July 2021, compared to a year ago. The credit risk funds of Nippon India MF, UTI MF, IDBI MF, HDFC MF and ICICI Prudential MF saw the largest increases. Their exposure to these debt instruments increased by 13 to 27 percentage points between July 2020 and 2021.
“The AA segment offers good credit spreads without excessive credit risk. As a result, the overall exposure of credit risk funds has shifted to the AA segment, ”says Kaustubh Belapurkar, Research Director, Morningstar India. Although corporate bond spreads have narrowed in the last year to July 2021, three- and five-year AA-rated bonds still offer an additional 80 to 86 basis points compared to comparable AAA-rated bonds over the course of the year. of this period, which makes them reasonably attractive.
At the same time, 11 patterns (not necessarily the same as above) reduced their exposure to risky debt securities A / A + / A- between July 2020 and 2021. IDBI CRF, Nippon India CRF, PGIM India CRF and Kotak CRF were the most exposed reductions of 20 to 39 percentage points during this period. Greater caution in the post-pandemic period, as well as the need to be able to manage buybacks smoothly, may have sparked this movement.
Comfort in safe assets
SEBI’s new liquidity rule for open-ended debt funds has resulted in an increase in the percentage of cash and sovereign debt instruments with credit risk regimes over the past year. The rule requires these funds to hold 10 percent of their net assets in liquid assets, including cash and government securities. In July 2021, 12 credit risk funds had increased their liquidity compared to what they were in July 2020. During this year, the largest increases (16 to 42 percentage points) were observed in credit risk funds of PGIM India MF, DSP MF, Baroda MF, BOI AXA MF and Kotak MF. For Kotak CRF and DSP CRF, debt securities maturing in late July 2021 have pushed plan cash levels above the mandatory minimum. That should change once the money is deployed. In July, 10 credit risk funds also held a higher proportion of ultra-safe sovereign debt instruments than in the previous year.
What’s in store?
A combination of factors has led to a reduced risk situation in the portfolios of many credit risk funds. While this could be positive from a risk perspective, it could potentially suppress future returns. Over the past year, the credit risk fund category has returned on average 8.3%. In comparison, safer corporate bond funds underperformed 5.2% over this period.
The resumption of credit growth and increased issuance of debt securities in the AA and lower segments could, however, provide more investment opportunities for credit risk funds. Investors should watch for changes in the risk profile of these funds to get an indication of future returns before taking the plunge.