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The series of debt defaults by large corporates in last 18 months has suddenly made investors shy away from debt mutual funds, even as expectations of a fall in interest rate could benefit certain categories of debt funds.
Not all debt funds were impacted and, investors consequently avoiding debt funds completely can be detrimental in the long run, said Amit Bhosle, Head, Risk Management, ICICI Prudential Asset Management Company.
Like amoeba in biology, investment risk always changes shape. Half the problem will be solved if one understands investment risk, he added, while speaking at the Smart Investor webinar titled ‘Risk Management in Debt Mutual Funds’, jointly presented by BusinessLine and ICICI Prudential Mutual Fund. He was in conversation with Radhika Merwin, Associate Editor, BusinessLine .
Mutual funds deploy reputation as capital. Once they deliver a bad experience, investors are wary to park money again in mutual funds. While financial capital can be regained, reputation cannot be earned once it is lost, said Bhosle.
“There are various changes that impact debt funds such as interest rate and credit spread. All investments in a fund’s portfolio have to be valued on a daily basis (impacting the NAV). While this more dynamic in nature it also presents challenges,” adds Bhosle.
Safety, liquidity and return – that is the investment philosophy that we have been advocating – which finds root in the construct of the mutual funds itself, explains Bhosle.
Risk and return are two sides of the same coin, and investors cannot expect to generate unlimited returns without exposing oneself to commensurate risk.
While investing in debt mutual funds, the entire narrative is often built around the concept of YTM (yield-to-maturity). “If the interest rate call goes right the potential future return is the YTM multiplied by rate of change in interest. But once credit risk is injected into this then the new set of challenges as credit and liquidity risks are asymmetric in nature. In credit risk, if the call goes wrong possibility of losing the principal is high,” explains Bhosle. Hence, reducing the entire investment construct in debt mutual funds to just YTM may not be in the interest of investor. One must look at risk adjusted returns.
No super heroes
There are no super heroes in debt funds. If one relies on an individual fund manager to rescue an investment, then that itself is a recipe for disaster. Investors can choose appropriate categories of debt funds for investments, depending on their risk appetite. SEBI’s recent guidelines for evaluating the risk levels of a scheme – taking into account credit, interest rate and liquidity risk in case of debt funds – which is accordingly depicted by the risk-o-meter, will increase the level of disclosure for the entire industry.
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