Credit funds move down rating curve; risk profile worsens in 2018-19

According to experts, the fall in exposure to the highest-rated papers was the result of a forced sell-off of liquid papers to deal with redemption pressures during the second half of 2018

Higher incidents of downgrades, combined with renewed risk-appetite among fund managers, have led to an uptick in credit risk funds’ exposure to lower-rated assets.

These schemes’ exposure to less than AA-rated papers rose from 25 per cent at the end of March 2018 to 28 per cent as of January 31, 2019. At the same time, exposure to highest-rated papers, which offer liquidity in tough times, has dropped from 15 per cent to 12 per cent.

“The spread assets are looking attractive. There is an opportunity to make money in some of these papers, and that is the reason for some buying in this segment. This, along with instances of downgrades, has led to higher exposures to lower-rated instruments,” said the fixed-income head of a fund house.

According to experts, the fall in exposure to the highest-rated (AAA) papers was the result of a forced sell-off of liquid papers to deal with redemption pressures during the second half of 2018.

In September, the default by Infrastructure Leasing and Financial Services (IL&FS) led to a liquidity squeeze in the debt market, which created panic among investors.

As investors started pulling out of debt schemes, credit funds also saw some outflows. 

Illustration by Ajay Mohanty

Before the IL&FS group default, the assets under management (AUM) of credit risk funds stood at Rs 86,813 crore at the end of August. As of January 31, 2019, the AUM of these funds are down to Rs 80,863 crore.  

Overall, debt schemes (non-liquid schemes) have seen more than Rs 80,000 crore of outflows in the last six months. 

Debt schemes’ AUM is down by more than Rs 60,000 crore from the August-end tally of Rs 7.5 trillion. For the current financial year, the category has seen more than Rs 1.3 trillion of outflows.

Analysts tracking the mutual fund (MF) industry say that the change in the composition of these schemes could make it more challenging to deal with another bout of liquidity tightening and redemption pressures.

Besides lower exposure to AAA-rated papers, these schemes’ exposure to other sources of liquidity has also reduced. 

For instance, exposure to government securities and overnight instruments has fallen from more than 2.5 per cent as of August 31, 2018, to just 0.2 per cent as of January 31, 2019. The cash and cash equivalents accounted for 4 per cent of these schemes at the end of January.

Fund managers say over the long-term quality of credit risk funds’ portfolios will improve.

“Most of the exposure in less than AA-rated papers are expected to mature in the next one year. Portfolios of mutual funds (MFs) are expected to improve as MFs are expected to reduce lending to lower-rated papers. We don’t expect less than AA rated exposure in MF portfolios to increase going forward,” said Murthy Nagarajan, head-fixed income, Tata MF.