Over the past two years, many debt mutual funds have been in a sticky spot, due to their exposure to certain NBFCs and corporates that have defaulted on debt repayments. Retail investors have been hit hard, with the slew of defaults and downgrades not appearing to ease anytime soon. Nimesh Shah, MD and CEO of ICICI Prudential Asset Management Company, believes that by not chasing higher yields and following an independent assessment of credit, ICICI Prudential has managed to ride out the volatility well and contain risk in the recent times. He believes that for investors in debt funds, safety must be paramount, followed by liquidity, then returns. Excerpts:
In view of the series of downgrades and defaults in debt instruments held by mutual funds in the last two to three years, do you think there is an industry-wide issue that we should be concerned about?
No, I don’t think the debt issues in some NBFCs are systemic. The base of the issue is the real estate sector. NBFCs that have invested in real estate could face some problems. Mutual funds that have parked their money in these NBFCs can, in turn, see some pain.
But only certain NBFCs are facing funding issues. On the other hand, banks and mutual funds have only increased lending to NBFCs over the past year.
How have you managed credit risk in your debt portfolio?
In the past two decades or so, ICICI Prudential Mutual Fund has not seen a single default or delay in payment of interest in any of its schemes. A key reason why our funds have managed to avoid credit defaults is because 10 years ago, we took a conscious decision to separate credit-risk management from fund management.
One of the biggest issues with some mutual funds that have been impacted by recent credit defaults, has been their high reliance on external rating agencies. Many of these funds had a higher yield to maturity (YTM) than our schemes.
But we believe that by not chasing higher yields and following our independent assessment of credit, we have managed to ride out the unfavourable credit environment well, in recent times.
Also, our credit-risk portfolio is well-diversified — it is spread across 80 securities. Hence, if there are any incidents, our diversification helps mitigate the risk. For instance, in case of Zee (not a default), while we received full repayment of principal and interest, our exposure was only about 1.56 per cent of the net asset value (NAV), which would have helped contain the risk in case of any unfavourable event.
What should investors in debt funds do to shield themselves from risks hereon?
Investors have to remember that, in India, typically, when you move a notch or two lower on the rating scale, while your risk increases, returns do not move up commensurately to justify the higher risk.
We believe that for investors in debt funds, safety must be paramount, followed by liquidity, then returns. Investors chasing higher returns end up taking higher risk. For investors, the past one to two years can be a good learning experience; they can opt for funds that have managed to contain the risk from the slew of downgrades and defaults. How various debt funds have performed over the past one to two years, can be a good indicator for investors to decide on their investments.
Is the current rally sustainable given the sombre performance of India Inc?
It is a narrow rally led by large caps. Even within large caps, certain stocks have done well, leading to steep valuations. It is not an India-specific problem, but a global one. We have been reiterating that balanced advantage funds, where equity allocation changes with market conditions and valuations, are a good way to earn returns with relatively lower volatility. Given that the market is expected to be volatile over the next one to two years, investors should look at dynamic asset-allocation funds as a category.
SEBI brought in a series of regulatory changes. It imposed a ban on payment of upfront commission last October and revised total expense ratio (TER) limits sharply from April 2019. How has this impacted ICICI Pru MF’s revenue and profitability?
SEBI’s regulatory changes are beneficial for both investors and mutual funds over the long run.
Brands which are well established and have demonstrated good long-term track record will be able to draw in new investors.
On the TER front, a lower expense ratio, implying better returns for investors, is also a huge positive for the industry in the long run. Hence, the product offerings are beneficial for customers.
Sometime back, there were concerns over mutual funds being active in loans against shares to promoters. SEBI tightened the norms and mandated that four times the loan amount (from the usual 1.5-2 times mutual funds carried) be held as collateral. What has been its impact?
In India, when promoters need capital to invest in a new venture, they pledge their shares and raise money, predominantly from non-banking players such as NBFCs and mutual funds. With the new norms in place, promoter-funding through loan against shares will likely not happen.