Bigger daddy makes you attractive

MFs eye paper of conglomerate-backed SMEs; there are benefits for both sides

Debt fund managers are generally averse to investing in securities of mid-sized and small-sized companies. These days, they are making exceptions.

These money managers are increasingly investing in papers of mid-size companies backed or owned by highly-rated industrial groups. Such investments are helping them get additional return, while keeping credit risks lower at a time when most lenders are facing the danger of credit defaults.

Fund houses are investing in papers of Tata Motor Finance, Aditya Birla Retail, HPCL Mittal Energy and IL&FS Transportation, among others. For these companies, issuing of securities, mostly commercial paper (CP), to mutual funds (MFs) helps them borrow below the bank base rate.

"It is cheaper for creditworthy companies to issue tradable paper at this point than take a loan from banks. By issuing tradable securities, these companies could tap investors like MFs, and this could lead to a reduction in their borrowing costs, as compared to availing loans," said Vikrant Mehta, head, fixed income, PineBridge Investments.

For instance, a company looking to raise capital through banks would be charged an interest rate of 10 per cent on a two-month loan. If it issued a two-month CP, it borrows at eight per cent.

"As MFs operate in the open market, these companies can borrow at market-related rates, which are closer to the repo rate," said Mahhendra Kumar Jajoo, executive director, Pramerica Asset Managers.

Most of such companies raising money from MFs fall in the category of small and mid-size companies. Funds usually prefer investing in large companies with a high credit rating because of lower credit risks. Buying securities of smaller companies provide the advantage of a spread differential.

"The differential could be between 20-25 basis points to 100 bps, depending on the credit-worthiness of the issuer and the sector it operates in," said Dwijendra Srivastava, head, fixed income, Sundaram Mutual.

This essentially means a paper issued by a higher-rated company would command a rate higher than the one issued by a company with lower ratings. The extent of this difference depends on the sector. For instance, the difference between rates of two companies in the realty sector would be much higher, say, at 100 bps. In a sector such as financials, it would be only 20-25 bps.

Fund managers said paper with AAA-ratings are in short supply because all the 44 MFs end up chasing the same large corporate house. Sebi's move to bar MFs from increasing their debt scheme exposure per sector to more than 30 per cent of total investments would also force funds to spread these.To that extent, fund houses are required to reduce exposure to sectors like non-bank financials, which have exposure up to 70-80 per cent in the case of certain schemes.