Credit-oriented schemes: Debt papers' downgrades spook retail investors

Data from the Association of Mutual Funds in India shows that the combined outflows in credit risk funds and medium-duration schemes in April was Rs 1,783 crore

Retail investors in credit-oriented schemes, who expected little volatility and steady returns from their investments, are now in an exit mode. This is on account of concerns over returns being hit due to write-downs of debt papers downgraded to ‘below-investment grade’ and mark-to-market losses after adverse ratings. 

“Some of these schemes have had to take a significant markdown on their exposure to downgraded papers, thus triggering a fall in the net asset values (NAVs). Some credit risk funds don’t have exposure to just one single lower-rated paper but multiple ones,” said Vidya Bala, head of mutual fund (MF) research at FundsIndia.

“There have been instances in which the fall in NAV after the markdown was equivalent to the entire year’s return for the scheme,” said a fund manager, requesting anonymity.

Data from the Association of Mutual Funds in India (Amfi) shows that the combined outflows in credit risk funds and medium-duration schemes in April was Rs 1,783 crore.  

“Outflows may continue for next few months as retail investors are getting sensitive to the credit risks in these schemes,” Bala added.

According to industry estimates, the assets managed in such schemes have continued their fall in May, too. Data collated by IDFC MF — which also includes other credit-oriented duration schemes — shows assets managed in these schemes had dipped to Rs 1.2 trillion as of May 8. This was a fall of Rs 1,733 crore, as compared to the asset levels on April 30. Sources said credit-oriented schemes were pushed as alternatives to fixed deposits citing better returns, by some segments of the industry.

“Investor mix in these schemes is largely retail, given that institutional investors typically prefer to park funds in shorter duration funds. Also, such schemes have high exit loads, which is, again, not conducive for institutional investors’ needs,” said a debt fund manager.

Debt markets have been in a state of volatility since the Infrastructure Leasing & Financial Services (IL&FS) crisis, with liquidity crunch putting pressure on lower-rated borrowers with weaker balance sheets.

Industry data shows that since September, these credit-oriented schemes have seen their assets fall in seven of the last eight months. 

Overall, the size of credit-oriented schemes has fallen by Rs 16,000 crore during this period. At the end of April, assets managed in such schemes stood at Rs 1.24 trillion, reflecting a fall of 11 per cent from before the IL&FS crisis.  

Investors, who have remained in credit schemes that have exposures to the lower-rated debt papers, now face concentration risks. A study by a fund house showed that as of March, 25 open-ended schemes with a combined size of over Rs 20,000 crore had concentrated exposures of above 10 per cent to a single issuer rated A-plus or below. 

“Fall in overall asset size of the exposed schemes has increased such schemes’ concentrated exposures to lower-rated papers. To meet redemptions, fund managers end up monetising higher-rated papers as lack of liquidity makes it difficult to offload downgraded instruments,” said a debt fund manager, requesting anonymity.

Meanwhile, some advisors reckon that the spike in corporate bond yields offers an opportunity, but not all market participants agree. 

“The recent expansion of spreads in lower rated bonds could be overstated. Key factors contributing to the expansion in spreads have been stress in weak non-banking financial companies, and loans against shares. When adjusted for these two segments, the spread expansion is not so stark,” said Arvind Subramanian, fund manager (fixed income), IDFC MF.