How to check the health of debt MFs

How to check the health of debt MFs

The unfolding of many adverse credit events over the last couple of years has highlighted the risks associated with investing in debt mutual funds to investors.

These funds have often been mis-sold as a higher-return ‘safe’ alternative to fixed deposits. As with other investments, these funds too require a credit risk assessment.

You can use the MF monthly fact sheet along with some online search for a basic credit quality check before you invest. Here’s how you can go about it.

Best-in-class

You can begin by checking what percentage of a debt MF scheme portfolio is invested in the highest rated papers. That is, how much is in AAA and A1+ (that is, AAA and equivalent) and sovereign debt papers.

AAA is the highest rating assigned to long-term debt instruments, those with a maturity of over one year. A1+ is the highest rating for short-term debt instruments such as commercial papers (CP) and certificates of deposit (CD) with a maturity of up to one year. Instruments with these ratings are meant to carry the lowest credit risk with respect to principal repayment and interest payments.

Sovereign debt papers comprising Government of India bonds, State government bonds and Treasury Bills are ranked the highest on the safety front.

If you want to play safe, you can narrow down on debt MF schemes that invest a high percentage, say over 90 per cent, of their portfolio in such instruments. Also, be sure to check the scheme portfolio over a period of time to ensure that this has been done consistently.

It’s not the same

Mahendra Jajoo, CIO – Fixed Income, Mirae Asset Investment Managers India, says that while AAA and A1+ rated papers are usually clubbed together from a credit quality perspective, not all A1+ rated short-term instruments can be considered equally safe.

This is because the issuers of short-term A1+ papers may not themselves always enjoy the highest long-term ratings. To get a better grip on this, one can check the long-term ratings for these issuers on the websites of rating agencies such as CRISIL, ICRA and CARE Ratings.

Also note, many AAA ratings are suffixed by SO (structured obligation) or CE (credit enhancement). AAA (SO) and AAA (CE) cannot be treated completely at par with AAA ratings.

These are assigned to debt papers where the standalone rating is below AAA and has been enhanced (and hence suffixed by SO or CE) by way of a guarantee, pledge of shares or escrow mechanism where cash flows meant for debt servicing are deposited by the borrower in an escrow account, and the like.

Typically, long-term ratings, in order of highest to lowest are: AAA, AA+, AA, AA-, A+, A, A-, BBB and so on. Similarly, short-term ratings follow the order: A1+, A1, A1-, A2+, A2, A2- and so on.

Perpetual bonds

After the write-down of Yes Bank AT1 bonds, which were also held by many mutual fund schemes, perpetual bonds came under the spotlight.

Perpetual bonds (including AT1 bonds) have no maturity date and the issuer has the option to simply keep paying interest on them without returning the principal. The interest payment too can be skipped if the issuer has incurred losses.

It would therefore help you to know if a debt MF scheme holds perpetual bonds (riskier than regular bonds) in its portfolio. But, this information may not always be disclosed in the fund fact sheet. You can, however, ascertain this with some research. You can go to the AMFI website (tinyurl.com/debtmf) to access the portfolio disclosure for most mutual funds.

You can take the ISIN (International Securities Identification Number) code for any security from here and use it to check on the CDSL or NSDL websites whether a bond is perpetual or regular.

There is another way too. Joydeep Sen, a corporate trainer (debt markets) and author, suggests that if the rating on a debt paper (say, a corporate bond) from a particular issuer, in a scheme portfolio is lower than what it would usually be, then it is likely to be a perpetual bond. You can find the usual rating for any company’s bonds from rating agency websites.Apart from the usual bonds, CDs and CPs, you may also find a portion of a debt MF corpus in reverse repo and triparty repo (TREPS), both of which are unrated instruments. These are sometimes shown separately (under 5 per cent) and at other times, along with cash and term deposits in the factsheet.

Both reverse repo and tri party repo are collateral-backed (government securities) short-term borrowing-lending transactions. The former involves only the borrower (company) and the lender (mutual fund in this case) and the latter involves also an additional third-party intermediary such as the Clearing Corporation of India. Practically speaking, both reverse repo and tri-party repo are considered not risky.

This article is auto-generated by Algorithm Source: www.thehindubusinessline.com

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