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Default on repayment of NCDs by an auto component company has created huge ripples in the debt markets. On top of that downgrade of one of the companies in the steel sector has created a paranoia kind of situation in the minds of Advisors & Investors alike. All are looking to take the first opportunity to exit out of debt market schemes from these Credit Accrual schemes. Let us analyse roles of some of the market participants in this whole chain to take some rational decisions rather than have knee jerk reactions & repent at leisure.
Rating agencies
First & foremost let us analyse the role of the Rating Agencies in this whole saga:
Rating of Amtek Auto by Rating Agencies on different Dates
On top of that the Treasury scheme which had invested in the said security was rated AAA by CRISIL. This rating continued even after CARE suspended rating for Amtek Auto NCDs on August 07'2015.Finally Brickworks downgraded the said NCD to C on August 27'2015. This AAA rating continued till CRISIL revised this rating from AAA to A+ at scheme level on September 01'2015.
Now looking at the above scenario, how can an Advisor or an ordinary investor who looks at these scheme ratings & security ratings (treats them like ISO certification before buying any product) & then invests their funds be held responsible for not doing due diligence before investing?
Who is to be blamed in this case? Advisor who recommended the said scheme/s, Investor who invested in the said scheme/s, Fund Manager who invested in these securities or the buck stops at the doorstep of the Rating Agencies who had given these ratings & revised the ratings only when the actual event of default occurred & hence were reactive rather than being proactive in downgrading these ratings from time to time?
Regulatory provisions
Now let us look at the Role of the Regulator who prescribes broad framework of investments by schemes of an AMC:
Currently SEBI directive gives following broad guidelines for investments by an Investor in a scheme & AMCs investments in Debt securities:
20/25 rule
20/25 Restriction states that each scheme should have minimum of 20 investors with not more than 25% of the scheme corpus with one single investor. This can reduce concentration risk to begin with. However, once a scheme corpus grows, the same restriction can come to hound the scheme on liquidity risk. Assume a scheme corpus of Rs.3,000 crores. Naturally the first criteria of 20 investors can be easily met with. However, further assume a single investor having an exposure of Rs.750 crores (maximum allowed to be invested by a single investor viz. 25% of the scheme corpus). This concentration of investments in a scheme by a single investor can harm the overall scheme performance & returns of other investors if the said investor decides to redeem out of the said scheme. In such uncertain times when all of a sudden credit is viewed with suspicion; without adequate knowledge an investor can very easily decide to exit from the scheme & create the so called 'Credit Issue' into a huge liquidity issue for the Fund Manager of the scheme.
Time for 20/25 to become 20/5?
Hence, to counter this concentration risk, the Regulator may wish to look to further make this rule of 20/25 more stringent by stating that not more than 5-10% of the scheme corpus be held by a single investor; thereby converting 20/25 to maybe 20/10 or 20/5.
Absolute amount restriction per investor
Other way to avoid this concentration risk is at the AMC level. Within the Rule of 20/25; AMC can decide to restrict accepting from a single investor not more than a specific amount.
This is being done by some of the AMCs like ICICI Prudential (I Pru) AMC & Franklin Templeton (FT) AMC who restricted per folio investments to say Rs.5 crores from an investor. This limit was enhanced to Rs.25 crores per folio in some schemes from an investor when the scheme corpus grew beyond a certain threshold. This takes care of the concentration risk arising from a single investor investment in a scheme. This will also ensure a much larger participation by many investors & spread various risks over a much wider audience (as & when these risks emerge; thereby mitigating the liquidity risk.)
Exit loads
Another way AMCs ensure reducing this liquidity risk is by putting very stiff staggered exit loads in some of their Corporate/Credit Opportunities bonds. Like FT schemes have very stiff exit loads in place in a staggered manner in their Short Term, Income Opportunities & Corporate Bond Funds. This gets staggered like exits before 1 year-exit load of 3% , 2% over 2 years & 1% over 3 years & so on & so forth. This dissuades investors from taking hasty decisions on exits.
Issuer concentration
Also, though SEBI allows investment in a single issuer paper upto 15% of the scheme corpus, this can also create concentration risk at the scheme level when such credit defaults happen. However, due to following investment guidelines by SEBI, many times Fund Managers have to resort to having higher exposures to single issuer upto maximum permissible limit.
SEBI also gives direction on investments by a Debt scheme on sector allocations:
Mutual Funds/AMCs shall ensure that total exposure of debt schemes of mutual funds in a particular sector (excluding investments in Bank CDs, CBLO, G-Secs, T-Bills and AAA rated securities issued by Public Financial Institutions and Public Sector Banks), short term deposits of scheduled commercial banks) shall not exceed 30% of the net assets of the scheme; Provided that an additional exposure to financial services sector (over and above the limit of 30%) not exceeding 10% of the net assets of the scheme shall be allowed by way of increase in exposure to Housing Finance Companies (HFCs) only; Provided further that the additional exposure to such securities issued by HFCs are rated AA and above and these HFCs are registered with National Housing Bank (NHB) and the total investment/ exposure in HFCs shall not exceed 30% of the net assets of the scheme."
In short
Scheme cannot invest more than 15% per Issuer Not more than 30% in a single sector (exception being securities issued by the Banking sector like CDs, G Secs - where there is no restriction. It can be 100% exposure to Bank CD portfolio in a scheme) Besides overall limit of 30% which can be invested in NBFC as a sector, additional 10% can be invested in Housing Finance Company papers with rating of AA or higher
Hence, when a Fund Manager constructs a portfolio for any debt schemes, he has to take into account overall limits as stated above. This can put restrictions on a Fund Manager in terms of the overall universe from where he can select debt papers. Over past few years very few manufacturing companies have accessed debt markets & hence debt securities issued by manufacturing companies are difficult to come by. This in turn restricts the Fund Managers' overall universe from where he can construct the scheme portfolio. In this scenario they have to buy more papers from Banking sector (to compensate for lack of availability in papers of manufacturing companies) with much lower yields. To compensate for this low captured YTMs, Fund Managers have to go down the credit path for capturing better yields for the entire portfolio.
Here all market participants need to share the responsibility as investors were promised very high YTMs & returns in accrual debt schemes. Advisors selected schemes based on higher YTMs, this put pressure on Sales Teams of AMCs who in turn pushed the Fund Managers to capture better yields even at the cost of going down the credit curve & this then became a vicious cycle.
Some thoughts worth reiterating here
I remember sharing my thoughts on this issue in many platforms & workshops that I conduct with IFAs. I used to point out following things:
a) High expense ratio of almost 2% plus in accrual debt schemes. This means that on a captured YTM of say 10%, we were taking away 20% of returns potential of investors. Even when these YTMs came down to say 8%, the said expense ratio continued; thereby eroding returns potential by a whopping 25%. Simple solution I had suggested was to create a variable expense ratio as % of YTM & on lower side then the current market practice of charging such high expense ratios.
b) Let us assume that AMC reduces expense ratio from 2% to 1% on variable basis. So at 10% YTM, expense charged to the scheme will be 1% & when the YTM comes down to say 8%, expense charged will come down to 0.80%. This will automatically improve captured YTMs of accrual schemes without going the credit path
c) Whenever we talk about accrual, it is treated as synonymous with credit. Why can't accrual be from AAA or AA+ securities? Why do we need to go the credit path to generate better returns? Remember Investors were & are happy with 6% post tax returns in FDs. All we have to do is better this on pretax basis; which can be easily achieved with even best quality papers. Due to tax advantage in favour of MF debt schemes, on post tax basis as well we can do better with Indexation benefit & lower tax slab of 20% for holding period of 3 years & above. Once again this reiterates my argument of giving decent pretax & post tax returns without going the credit path.
Some of the AMCs like ICICI Prudential has been disclosing entire portfolios of all their holdings in all their debt schemes alongwith % of holdings in each of these securities. This analysis will give guidance to advisors on concentration risk, etc. This should be made mandatory for all AMCs to disclose this in their monthly fact sheets.
Hence to conclude
Before jumping to any conclusion & without being judgmental please analyse each AMC on above parameters & find the robustness of their systems Stop relying only on Credit Rating agencies as I have demonstrated above as to how hollow & misleading it could turn out to be AMCs also should have in house expertise on credit analysis of papers they wish to invest & not rely only on Credit rating agencies to select their investments Even within the overall limits laid down by the Regulator, each AMC should have some prudent norms of restricting investment per folio to reduce concentration risks arising out of some large investors. In short there should be broader investor participation in each scheme rather than having concentrated participation from few investors. This will also avoid liquidity risk Again, within overall guidelines laid down by the Regulator on investment side, AMCs should have in house restrictions on their investment patterns At industry level, each participant like Advisor, Sales Teams of AMCs & Fund Managers, make an effort to educate investors of investing in maybe lower YTM accrual schemes with better quality papers. Wean them away from greed of higher accruals from lower credits Some of the AMCs like Franklin Templeton & ICICI Prudential have set these prudential norms which are beyond the guidelines given by the Regulator. They also have in house expertise with huge teams only to analyse credits & not depend on only rating agencies for selecting their securities Only after understanding all the above aspects in detail can an Advisor take an informed decision on whether they should or should not continue investments of their clients in these Credit Accrual themes Otherwise, ill informed decisions will not only harm their clients' portfolios but will harm the entire industry if so called Credit Issue gets escalated to Liquidity issue. This will shake the confidence of investors in Mutual Fund industry itself All of us have worked really hard to bring the confidence of investors in MF schemes. Let us not shake that with our ignorance & ill informed decisions Fortunately, this time around the industry & its participants have acted very maturely. This is being seen by the September end AUM numbers in some of these Corporate Bond funds. It reflects that there has been hardly any redemption pressures in this Bond Fund category (just contrary to rumors which were floating around in the market before the month end of huge redemptions from Credit themes) This asset class will have its place in any investor portfolio & should continue to be so. Duration products aim to generate outperformance through timing of the interest rate movement at the macro level. At some time in near future, this cycle will halt & maybe reverse as well. With 3 year investment horizon (due to tax issues), this call then becomes a trading call & short term call; thereby attracting short term gains tax & eating into the returns One of the prerequisites of successful investing in Corporate Bond funds is to invest with the right horizon, identify the right fund & stay invested in line with the horizon. Corporate Bond funds have shown greater alignment of returns with portfolio yields without timing the markets
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