Nifty99000 100%

Sensex99000 100%

Exclusive

Don’t Shy Away From The Debt Funds, Understand The Risk

Author: D P Singh/Wednesday, July 22, 2020/Categories: Exclusive

Rate this article:
No rating
Don’t Shy Away From The Debt Funds, Understand The Risk

There is a saying that ‘Challenging times teach us important lessons!’ All the unexpected events faced in the past by humankind – be it the scale of a global pandemic or environmental issues or even one-off market events– have taught us a lesson and paved the way for evolution helping us emerge stronger and wiser. It is important to stay calm through these events and learn from the experience.

We are currently going through unprecedented times with the outbreak of Covid-19 pandemic. Every citizen across the globe is exposed to its negative implications and so are the businesses. With lack of clarity on the extent of impact this outbreak will have on the global and domestic economy, market functioning has also been disrupted. While dealing with the pandemic crisis, the mutual fund industry was faced with another challenge recently with the closure of six of debt schemes, which resulted in widespread panic among the investor community.

Often investors tend to compare debt mutual funds with other traditional investment avenues. The need of the hour is better understanding of the functioning of these products and how they differ from other traditional investment avenues. Let us understand this from the current market perspective. The reason of closure of six of the debt schemes in the industry was lack of liquidity (the capacity to convert the assets to cash easily) at scheme level to meet investor redemptions. Investors need to understand that liquidity in case of mutual fund is different as compared to say bank deposits.

The money deposited by an individual in banks is classified either as time or demand liability. The difference is time liability are due for payment at a fixed time, whereas demand liabilities need to be repaid as and when requested by individual depositors. In order to keep the liquidity buffer to meet these requests bank can’t lend all of the money deposited with them. As per regulations, banks are mandated to set aside a percentage of the Net Demand and Time Liabilities (NDTL) defined by Cash Reserve Ratio (CRR is currently 3% of NDTL) and Statutory Liquidity Ratio (SLR is currently at 18% of NDTL) to maintain liquidity to meet individual requests. This helps in creating a robust liquidity system for banks.

When it comes to money invested in mutual funds, the functioning is however different. Mutual funds have no such mandate to set aside a sum of money they receive to meet liquidity requirements. Mutual fund schemes’ NAV (Net Asset Value) reflects the daily change in the market value of the securities the schemes invest in. These schemes manage liquidity needs by keeping a certain portion of the portfolio in cash. During times when the market sees heightened volatility, cash levels maintained by fund managers also get tested as investors start redeeming in panic. This is when the fund managers turn to second level of liquidity comes in picture, the credit quality of the portfolio.

Debt securities are assigned different credit rating based on the financial stability and capacity to repay the debt. Government securities (G-Secs) and AAA papers are relatively safer and carry less risk as compared to companies with a lower credit rating. At the fund level, liquidity is defined by the percentage of investments made in highly liquid assets such as cash equivalents, G-Secs and certain AAA papers. Because of the higher quality of these papers they can be easily transacted when needed. Thus, prior to investments, credit quality of a portfolio is a key aspect that needs to be evaluated to ascertain the overall portfolio risk.

Debt funds are classified based on their duration and it is advised that investors should look at investing in short, medium, or long-term funds based on their goals for e.g. for parking money for emergency situations investors can look at low duration or ultra-short duration funds and for longer term goals investors can look at medium duration or corporate bonds funds. However, it is very important to also look at the credit quality of the portfolio. A higher credit quality involves less risk as compared to funds investing in lower rated papers.

It is important for investors to consider all the risk factors before making any investment. While traditional avenues come with a pre-determined interest rate, it is pertinent to note that they are revised based on the prevailing interest rate scenario. On the other hand, while the returns of debt mutual fund schemes vary depending on the movement in underlying securities, different set of funds offer the potential to benefit from varied market scenarios. The return on each investment instrument is linked to the level of risk taken.

In very simple terms, starting a business involves risk, but that doesn’t stop an entrepreneur from following his/her dreams, but encourages him/her to take calculated risks based on the amount of risk they can absorb. Similarly, based on individual requirements there are an array of schemes with varied risk return profile within the debt category which mutual funds offer. The choice of scheme should be a function of one’s risk appetite, expected returns and investment horizon.

As the adage goes ‘’the difference between stumbling blocks and stepping stones depends on how one uses it’ same is true with debt mutual funds also. The key lies to use the stumbling blocks (uncertain market times) as stepping stones to look at systematic allocation in debt funds.

The writer is ED & CMO (domestic business), SBI Mutual Fund

Print

Number of views (294)/Comments (0)

Leave a comment

Name:
Email:
Comment:
Add comment

Name:
Email:
Subject:
Message:
x

Videos

Ask the Finapolis.

I'm not a robot
 
Dharmendra Satpathy
Col. Sanjeev Govila (retd)
Hum Fauji Investments
 
The Finapolis' expert answers your queries on investments, taxation and personal finance. Want advice? Submit your Question above

Categories

Disclaimer

The technical studies / analysis discussed here can be at odds with our fundamental views / analysis. The information and views presented in this report are prepared by Karvy Consultants Limited. The information contained herein is based on our analysis and upon sources that we consider reliable. We, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and we are not responsible for any loss incurred based upon it. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advice, as they believe necessary. While acting upon any information or analysis mentioned in this report, investors may please note that neither Karvy nor Karvy Consultants nor any person connected with any associate companies of Karvy accepts any liability arising from the use of this information and views mentioned in this document. The author, directors and other employees of Karvy and its affiliates may hold long or short positions in the above mentioned companies from time to time. Every employee of Karvy and its associate companies is required to disclose his/her individual stock holdings and details of trades, if any, that they undertake. The team rendering corporate analysis and investment recommendations are restricted in purchasing/selling of shares or other securities till such a time this recommendation has either been displayed or has been forwarded to clients of Karvy. All employees are further restricted to place orders only through Karvy Consultants Ltd. This report is intended for a restricted audience and we are not soliciting any action based on it. Neither the information nor any opinion expressed herein constitutes an offer or an invitation to make an offer, to buy or sell any securities, or any options, futures or other derivatives related to such securities.

Subscribe For Free

Get the e-paper free