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Are Your Debt Fund Investments Increasing Your Blood Pressure?

Here are the three things you need to learn immediately for now.

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Many investors in debt funds are looking at downgrades. Some funds have even seen erosion in the region of 10-20%of portfolio values. A few basic questions are there in the minds of all investors whether seasoned or first time.

Why did it happen?

IL&FS has a credit issue and as per fund houses only 25-30% of the monies are recoverable out of the 91000 plus crore exposure. The regulator has become concerned on account of the asset liability mismatch which was the fundamental issue for the crisis.

What used to happen was lending used to happen for a period of 15-20 years and borrowing is generally on a 5 year basis with a renewal. The regulator to avoid further crisis has mandated all non banking financial service companies to make the asset liability mismatch nil which means for a loan given for 5 years there has to be a liability for 5 years.

This has led to churning of assets at a balance sheets for various nbfcs .The relatively better ones are those with a lower time horizon (<5 yrs)  include consumer loan companies. From a safety factor consumer loan nbfcs, certain established hfcs, gold loan cos are better candidates for asset allocation.

What to look for going forward in debt funds?

The debt funds provide a indexation benefit and help generate a taxation arbitrage if they are able to manage the credit risk well.

The regulator has under the new classification of funds looked at broadly the following categories

1. Overnight
This is literally funds parked overnight

2. Liquid
These have securities between 10-30 day of maturity. As of now even A- is taken as eligible to be a part of the portfolio.

3. Ultra short term
these have securities with a tenure of 3-6 months. It can be considered for paper above AA+ rating

4. Low duration
This has paper upto an year of maturity. Ideally all such funds need below 3 years need to have a AA+ rating at the minimum. Right now it is left to the discretion of the fund management

5. Short term funds

These have paper with a maturity of 3-4 years. Good in a falling interest rate cycle as one might experience capital gains as an investor.

6. Medium term funds

These are funds with a 5 year focus on a maturity basis. It is good with a falling interest rate cycle subject to credit risk being in order.

7. Long term funds/gilts

This is corporate paper with a 5-10 yr horizon. If you want to buy directly from primary market minimum lot is generally 4-5 crores.For taxation and liquidity issues advisable to go through the mutual fund route.

Credit risk issues can be higher as exposure is to relatively stressed parts of the infrastructure/mining space.

Gilt funds are in the middle of the cycle as far as capital gains are concerned.

What is the road ahead?

The nbfcs have so far paid on time apart from the exception of dhfl, which paid after a week and was declared D status, implying a complete write off at the fund level. It is expected that situation will ease in the next 3—6 months.

A regulation has to be in place to ensure that short term paper is invested in AA+ categories. This would facilitate safety from an investor point of view.

A well regulated debt market would also create a deeper debt market making it easier for companies to borrow at lower rates and be competitive in India/overseas operations.

Once the rot is controlled, and new norms for asset liability mismatch established over the next 2-3 quarters, the government can consider adding debt funds to the 80C bucket from next financial year onwards thus initiating the job of deepening debt markets at a mass level.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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personal finance

Anirudh Gupta

The author is CEO & Principal Adviser at Ashiana Financial Services

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