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Risk Of Capital Is Not Something You Want To Take In Debt

Author: Kumar Shankar Roy/Wednesday, May 6, 2020/Categories: The Finapolis Conversation

Risk Of Capital Is Not Something You Want To Take In Debt

Radhika Gupta is an investment professional with a range of diverse experience across asset management globally and in India. She started her career with McKinsey, later switched to Wall Street, joining AQR Capital, a leading firm in hedge funds. She then moved to India in 2009 to start her own venture, Forefront Capital Management, which was acquired by Edelweiss Financial Services in 2014. She led Edelweiss’ acquisition of JP Morgan’s Mutual Fund business and Ambit Capital’s AIF business, to become the CEO of Edelweiss AMC in 2017. Since then, her efforts are concentrated in helping build brand Edelweiss AMC into a fast growing, differentiated and innovative asset manager. The recent launch of Bharat Bond ETF in partnership with Government of India, India’s first corporate bond ETF, is yet another step in that direction. In this week’s Finapolis Conversation with Kumar Shankar Roy, Radhika shares her insights on debt fund investing, the importance of knowing how your hybrid fund makes returns, and pitches Bharat Bond ETF as a safe alternative. Read to know more.

What are the takeaways for investors from the shaky situation in some debt funds?

Safety and liquidity really go hand in hand. Returns come much later. In the context of interest rates falling someone asked me what to do, I told them just because rates are falling, don’t push yourself to get one per cent extra return. Risk of capital is not something you want to take in debt. That risk should be taken in equity.

I genuinely believe investors and advisors need to ask tougher questions. One must ask questions about liquidity, about performance and about out-performance. And, this is not just limited to debt funds. It is for all fund types. For example, if you ask me why Edelweiss Balanced Advantage Fund has shown extreme out-performance in 3-month period, I would tell you that we were holding significantly less amount of equity. This is because it follows a trend based model. There is a reason for it. I hate questions like ‘what is the secret sauce?’ There is no secret sauce! If there is no proper answer for outperformance, that's a separate problem.

Does the categorization for debt funds need a re-look?

I think there is a need for Categorization 2.0 broadly. The first round of categorization was a good attempt. At least, you went from nothing to something. I feel there are a few things that need to be done from the categorization point of view.

First, one is you genuinely need to cut down the number of funds. There are far too many, especially in debt. You do not need 16 categories of debt funds surely.

Secondly, there is a need to fix the labelling on some of the debt funds. One needs to make sure that the debt funds are far more true-to-label. For example, they need credit boundaries. They need boundaries like you can’t hold papers that are structured in nature which includes some of these Put options and Call options, etc. Truth be told investors don’t understand duration, forget Macaulay duration. If AMCs want to do a few creative things, then there should be an institutional category for them. But, label a few funds as retail funds and keep them very simple. I even argue that there is a need to put tight boundaries in hybrid funds in terms of credit and duration.

Since you brought up the subject of hybrid funds, many experts have previously recommended that there should be a nuanced understanding of hybrid funds especially balanced advantage or dynamic asset allocation funds. How does an ordinary investor understand how one such fund is different from the others?

There are three things to understand. One, you look at the model, which helps shift between equity and debt. Ask what is the basis for that shift? Is that valuation, momentum or some third metric? Ask the AMC (asset management company) to give you a document of what that process is. Find out what is the maximum/ minimum asset exposure.

Second is the equity exposure info. Find out what is the bound on midcap exposure, what is the bound on small-cap exposure and how concentrated with the equity portfolio be. We have seen a few hybrid funds skewed towards midcap exposure. The emphasis on equity portfolio concentration is important because between a 20-stock portfolio and a 60-stock portfolio, the 20-stock one definitely carries more risk.

Third is that what are the boundaries on fixed income investment? Read the portfolio and see what is in it. While reading if you see papers of top private sector banks, then one should feel reasonably confident.

Due to the upheaval in debt funds, there are many looking at safer fund options. Is Bharat Bond ETF a safe option considering it has top-rated debt?

When Bharat Bond ETF was created, it was done with a vision that it become the go-to simple and safe product for retail investors. What we have been very happy with that is while we did a quick NFO, the retail investor interest in Bharat Bond is picking interest day by day.  Structurally it is most close to an FD type of structure, with 3 year, 10 year options. The only challenge is that we don’t have many options across, but we are working on providing them. As we do more offerings, there will be more tenures to choose from.

Bharat Bond ETF holds triple A (AAA) rated PSUs. There is no fund manager discretion on whether it’s AAA or non AAA, PSU or non PSU that exists in other funds. In fact, if something is downgraded below AAA for a certain period of time, it has to come out of the index (Nifty BHARAT Bond Index). So, it is most well-defined in terms of safety alternatives.

In terms of liquidity, we must tell investors that we have seen and handled large trading volumes. We have seen purchases of 500 crore and redemptions of 500 crore. Even in this market environment, we have been able to do them. We take pride in that. 

Coming back to debt funds, we now realize that many schemes have a lot more credit risk than we thought they had. When we ask experts, they say ‘avoid funds with credit risk.’ How does an investor or advisor find out how much credit risk is present in a debt fund?

The quickest way to catch credit risk plays is to look at the rating of the instruments. I know people have a problem on relying on rating agencies too much, and that ratings are not perfect etc. But for an average retail investor, ratings are a good indicator. Of course, you can check the names of the companies, but doing due diligence on each company is honestly not possible for an average retail investor.

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