Think Debt : Fund Manager Perspectives 05th Jan 2015
There's Rs.85,000 crs of industry AuM riding on credit evaluation. How well do you understand this?
Rahul Bhuskute, Head - Structured & Credit Investments, ICICI Prudential AMC

imgbd Think Debt is a joint initiative between ICICI Prudential MF and Wealth Forum, which aims at sharing new thoughts and new paradigms to help the industry make deeper inroads into the large pool of conservative retail savings that offers a huge growth opportunity for the retail debt segment of the MF business.

A key growth driver in this segment will be familiarity and expertise of distributors in understanding debt funds, which will enable them to advise clients appropriately. One of the aspects in this regard that receives much less distributor attention than it deserves is an appreciation of credit risk and therefore an understanding of credit evaluation processes adopted by fund houses. As Rahul aptly sums it up : there's Rs.85,000 crores of industry AuM in credit investments. How much attention are distributors paying to understanding credit evaluation processes? Debt fund management is not just about taking a top down call on interest rates - there's a lot of bottom-up work that is done, especially on the credit side, to enable alpha generation. Read on as Rahul takes us through what exactly he and his team do on the bottom up side of debt fund management.

WF : Most conversations between fund houses and distributors on debt revolve around the fund manager's interest rate view and products that look attractive at that point of time, based on a certain interest rate outlook. An aspect that often gets ignored is the credit evaluation aspect. How important is this function in managing debt funds? Why is this not an area of more focus in distribution engagement?

Rahul : Credit evaluation is the most critical aspectfor accrual funds. It also becomes relevant to non-accrual schemes that make credit investments in order to earn extra yields. Today, the total credit investments in the industry are over Rs.85,000 Crore; thus, highlighting the important of credit evaluation.

Credit investments primarily carry three unique risks: credit risk, concentration risk (i.e. the quantum of risk one is taking against one promoter or company) and liquidity risk since some corporate bonds are not as liquid as others. It is critical for fund managers and advisors to keep a keen eye on all of these risks.

Credit as an asset class has emerged only in the last few years so perhaps the learning curve is at a nascent stage as compared to fixed income or duration products. As for the distributor engagement, ICICI Prudential AMC is making consistent efforts through digital platform, besides traditional media- TV, Print, Outdoor and Conferences etc. to educate investors and their advisors about credit investments.

WF : Most of us are familiar on the equity side with the processes involved in equity research leading up to strong bottom up stock picking skills. Can you throw similar light on the security selection process that you follow for debt instruments?

Rahul : We have built a structured process around our asset selection exercise. After going through this rigorous process, where we took into account external credit ratings, track records of promoter and group companies and ICICI Group's experience, we have created a list of around 200 companies, which is our target list for investment. The companies in the target list were also discussed in great detail with the independent in-house research team; this team has no business targets and reports directly to the CIO. Again the list was sliced in terms of what kinds of deal we will do. This list is now the guiding force for the debt investments of the AMC.

Further effort has also gone into finding structures and asset classes where risk-return profiles are positively breached on account of regulatory arbitrage e.g. where commoditized providers of capital like banks are not present. For example, banks cannot provide financing to promoters or holding companies; banks cannot provide financing for domestic acquisitions and also for land acquisitions. Lastly, we also like to take an active credit call in some of the investments in terms of whether the rating is likely to be upgraded and if the market has not priced in any upside on account of that. So we are on a continuous lookout for such opportunities which would give us an alpha.

WF : What are some ways fund managers build extra protection when lending to companies, which retail investors will not have access to in company FD programs?

Rahul : Fund managers provide diversification benefits to investors which a company FD cannot offer. For example, ifone has invested Rs.100 in a company FD, the entire investment amount is at risk in case the company faces some issues. But if you invest the same amount in a fund which may have invested in around 40 securities, the exposure to one company may not exceed Rs 8 - 10. Thus, funds can offer diversification as they have the scale to make investmentsacross several securities.

For example our ICICI Prudential Regular Savings Fund has around 45 investments and the maximum exposure to one counterparty is not more than 7-8%. Similarly, ICICI Prudential Corporate Bond Fund has over 30 investments.

WF : Structured debt products that go into many accrual oriented debt funds often cause concerns among advisors, perhaps due to worries on liquidity, credit quality etc. What kind of structures add value in accrual funds and what kind of structures are best avoided?

Rahul : Structured debt investments rely on the value of the collateral or security and therefore before making such an investment we conduct a thorough evaluation of the underlying security. For example, if the underlying security is in the form of shares, the credit team engageswith the equity team for scrutiny.

Further, we form structured deals with companies having market capitalisation of at least Rs.10000 crore. We also prefer to keep the structure as simple as possible in order to analyse all category of risks efficiently.

WF : What differentiates one fund management team from another when it comes to debt fund management? What should advisors look for when trying to gain comfort on processes followed by a fund house in relation to managing debt funds?

Rahul : There are several factors to consider when looking at a fund management team in relation to managing debt funds. It is important to look at how well-resourced the team is in terms of the number of dedicated employees and relevant experience. ICICI Prudential AMC has a dedicated team of five resources for credit investments with an aggregate experience of 35 years.

One should also look at the process - how is the team managing the three critical risks mentioned above (viz. credit risk, concentration risk and liquidity risk). It is important to evaluate if there are individual exposure limits and limits on products such as structured products etc.

Another critical aspect is to measure the concentration of investment with respect to one company or one corporate group not just at a scheme level but also at a fund house level. ICICI Prudential publishes this information in the Annexure 1 of the factsheet. We believe this is critical information and should be sought while investing across the industry.

Lastly, it is essential to know the capability of the team to source deals directly with companies. At ICICI Prudential AMC, we originate a significant portion of our credit investments on a direct basis where we engage with promoters or CFOs, without any help of an intermediary. This enables us to save on arrangement fees thereby enhancing investor returns.



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