Red flags to watch out before investing in debt MFs
It is very sad to see that debt mutual funds, which are considered to be a safe option when compared to equity, are surrounded by back to back bad events. After the last year’s IL & FS fiasco, bad events continued their trail with Essel and DHFL defaulting on payments and getting downgraded by the rating agencies. Franklin event have further led to a fear among retail investors, when it comes to investing in debt MFs. Here are a few red flags that you should check before investing in debt MFs.
High concentration in one issuer
If the debt MFs are more inclined towards single issuer, then this is a red signal. As the fund is invested in various instruments issued by the same company, there is a company specific risk. This means that if a particular company starts running into losses and is not in a position to honour the payments, the mutual fund investing in such a company could be at a huge risk. Even one or two downgrades can have a huge impact on the fund’s performance.
High concentration in low-rated securities
In order to earn alpha debt, MFs tend to invest in low-rated securities as they provide higher interest rates. Though, nothing is wrong with it but some debt MFs go heavy on investing in these securities, which make their overall portfolio risky. A low-rated security means that there are less chances of borrower honouring the debt repayment. Though low-rated securities provide a high interest yet the risk is too high. The main intention of the investor in debt MFs is usually to invest for safety and not for returns. And if the returns are your highest priority, then it makes more sense to invest in equity MFs.
Ratings under review
Investors usually tend to rely more on the actual credit ratings and changes in the same. However, apart from this, investors must also look out for securities which are under review status by the credit rating agencies. This is the time when credit rating agencies re-assess the credit profiles of the securities and decides whether to upgrade, downgrade or keep status quo. While doing the assessment, if the rating agencies found that the issuer is no longer in a good position to honour the debt repayments then, they downgrade their ratings. Now, one may argue that how is it going to help? So, with this information, you can check the recent developments that are happening with respect to that issuer. This will help you to gauge in advance what might be the outcome of the credit ratings of such instruments which are under review.