Debt MFs confident of surfing Covid-19 2nd wave despite corporate defaults

Industry players say shift to high-quality paper will help them tide the turmoil

Debt mutual funds (MFs) have faced multiple headwinds in the form of defaults and downgrades since 2018, but the second wave of Covid-19 may not be one of them, even though it is expected to add pressure on the creditworthiness of India Inc.
 
The industry appears to be better prepared this time around, thanks to the large concentration of top-rated papers in its portfolio.
 
Before the default of Infrastructure Leasing and Financial Services (IL&FS) in 2018, debt MFs’ investments in government securities and AAA-rated papers amounted to 80-85 per cent of their total assets. Industry players say this has increased to over 90 per cent since.
 
Amit Tripathi, CIO – fixed income investments at Nippon India Mutual Fund, says the move towards high-grade papers was driven by a combination of macro factors such as the fiscal situation and the Reserve Bank of India’s monetary stance, as well as industry-specific factors, such as large inflows into high-grade funds, coupled with significant outflows from credit funds.
 
“Most open-ended funds continued to stay in the high-grade space since the rate environment was constructive and the opportunity cost of forgoing higher allocation to the non-AAA space in terms of ‘total returns’ was low. It’s been broadly status quo since then,” added Tripathi.
 
In the past, debt MFs have seen a fall in their net asset value (NAV) as they had to mark down the investments after a spate of corporate defaults.
 
Among the major credit incidents that hit debt funds were the defaults of IL&FS and Dewan Housing Finance Corporation (DHFL) and the write-down of YES Bank’s AT1 bonds. The closure of six debt funds by the Franklin Templeton MF last April made the industry and investors more risk averse.
 
The disruption in business activity due to lockdowns is expected to impact several businesses during the June quarter. This has prompted rating agencies to revise downwards the outlook for several sectors—a precursor to rating action.
 
Debt fund managers, however, are not ringing the alarm bells yet. They say the regulators have been very responsive in addressing risks to financial stability, which significantly influences the credit outlook.
 
“Liquidity measures coupled with one-of-a-kind targeted long-term repo operations (TLTROs) programme wrapped with hold-to-maturity (HTM) benefits has helped hasten this phase of deleveraging and ensured that we had less of legacy problems to address. This has enabled us to focus more on incremental problems. Lastly, for credit outlook to turn good, one needs positive growth momentum and lower cost of money. At the current juncture, both these parameters are ticked, implying lower risks for credit outlook,” said Saurabh Bhatia, head fixed income at DSP Mutual Fund.
 
Even rating agencies are of the view that the stress for corporate India would be towards unsecured category of loans and micro finance institutions.
 
“For debt MFs, I do not foresee any major problems at this point of time as most of the funds have invested in the top-quality papers. In the past two-three years there were some issues related to the credit risk funds. But even there funds have moved to good quality names. There can be some impact on debt MFs due to the changes in the interest rates, but not due to credit quality,” said Sanjay Agarwal, senior director at CARE Ratings.
 
Despite not witnessing any major risk of downgrades or defaults, fund managers continue to position their portfolio conservatively, say industry watchers.