Debt Funds in the middle of a storm

Earlier it was believed that volatility is part and parcel of equity or equity-dedicated mutual fund investment and investments in debt funds remain largely stable and safe. That has been changing in the last six months with a slew of events. First, it was the IL&FS default saga that many termed as India’s Lehman Brother moment, it casts a long shadow on the debt mutual fund space. It spooked many investors and many funds holding IL&FS paper saw a fall in their NAV. The recent turmoil in DHFL and Essel group companies have made the investment in debt funds looks riskier.

Various domestic debt mutual funds invested in DHFL and its likes are facing rising concerns about their exposure to these companies and their papers. According to one estimate, domestic MFs have an aggregate exposure of Rs. 8,500 crore, that is 70 basis points of debt AUM as of December 2018. Nonetheless, the exposure of some fund houses is larger. There are certain schemes that have exposure up to 30 per cent of their AUM to DHFL. These funds have taken a mark to market (MTM) losses on these papers as they are repriced at higher yields.  Various schemes have taken MTM losses on their exposure to DHFL. If it is followed by a redemption pressure, we may see a second wave of risk aversion in the domestic debt fund and volatility in flows. It is estimated that 30 per cent of the asset under management (AUM) of debt funds in India comprise paper from NBFCs including HFCs (Housing Finance Companies).  

Most of the investors invest in debt funds to meet their short-term needs and want returns better than savings bank (SB) account. They also park their funds in these schemes after some of their investments mature and they want safety as well as returns better than SB account. Events like this will have a significant impact on their entire financial goals hence it is always advisable to invest in debt schemes that invest in highest rated paper, even if it means a few basis points lower return.