Credit Risk Funds – It is time for mutual funds to take a relook at Credit Risk Funds

Credit Risk Funds Credit Risk Funds   It is time for mutual funds to take a relook at Credit Risk Funds

 

The troubles for credit risk funds began soon after the IL&FS fiasco. It actually got exacerbated by cases like Essel, DHFL, ADAG, Jet and Yes Bank. The real last straw was when Templeton opted to wind down six of its funds due to the pressure of redemptions. That posed a real challenge for credit risk funds.

Templeton effect

Just a week after Templeton decided to shut down six of its funds, the impact was virtually visible across credit risk funds in India. For example, credit risk funds saw redemptions to the tune of 25% of the overall AUM in just four days since Templeton announced its decision to wind down the funds. The AUM of credit risk funds fell from around Rs.48,000 crore to Rs.36,000 crore in just four trading days flat. The impact was not just felt on the credit risk funds but also on all the non-gilt funds where the funds had an exposure to credit risk. Ironically, many of the funds had taken on huge credit risk in short duration and medium duration funds. The irony was that the short duration fund invested in structured debt with 7-10 year maturity. That literally defeated the very purpose of a short duration fund. The impact of the Templeton winding down was not only felt on other funds of Templeton but across debt funds of other AMCs too. Clearly large corporate investors and institutions were not too pleased with the risks assumed by these credit rating funds in terms of quality.

Quality has been the issue

In a way, Templeton represents all that could possibly go wrong with a credit risk fund. Firstly, they allowed MF flows to dictate their investment strategy rather than be driven by their view on bonds. Secondly, many of the funds with different sounding names were also effectively credit risk funds due to the preponderance of credit risk in their portfolios. This applied even to short duration, medium duration and short to medium duration funds. In most cases, there was actually no link between the investment objective articulated by the fund and the quality of the portfolio. Lastly, many of these credit risk funds had invested in structured products which do not offer liquidity and are also extremely opaque.

Time for rethink on credit risk

If the current situation is anything to go by, then investors are really unhappy and jittery about the way credit risk funds are handled. Going down the rating curve to earn higher returns may appear like a simple strategy but it only works in good times. In times like COVID-19 when growth slows and defaults increase, the counter side of credit risk becomes apparent. As Warren Buffett rightly said, “It is only when the tide goes down that you realize who has been swimming naked”. That is exactly the state of flux where credit risk funds in India find themselves in today!

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